NOBULL: Unusual trading on Smithfield calls before deal raises eyebrows

Unusual trading on Smithfield calls before deal raises eyebrows

Thu May 30, 2013 1:09am IST

* Smithfield call volume on May 21 was above typical levels

* Upside July $29 and $30 Smithfield calls stand out

By Doris Frankel

May 29 (Reuters) – Bullish bets in the U.S. options market on Smithfield Foods Inc, placed before a takeover bid by a Chinese company, has raised concerns that the news may have reached some investors ahead of time.

Smithfield shares jumped 29.6 percent to $33.64 after China’s Shuanghui International agreed on Wednesday to buy the world’s largest pork producer for $4.7 billion in cash. . Shuanghui’s offer values Smithfield at $34 per share and represents a premium of 31 percent to Smithfield’s closing stock price on Tuesday.

About one week ago, there was heavy turnover in Smithfield upside call options expiring in July that would benefit from a sharp move upward in the stock price.

On May 21, combined turnover in the most active July $29 and $30 strike calls was above typical levels, and appeared to be opening purchases in what may be another instance of a buyout announcement that was preceded by questionable trading in the options market.

On that day, Smithfield shares closed at $25.79.

"The option flow on Tuesday was very quiet but a spike on call volume on May 21 may indicate some leakage," said Henry Schwartz, president of option analytic firm Trade Alert.

Smithfield call option volume averaged 1,400 calls per day over the last three months, according to options analytics firm Livevol. Call volume on May 21 was noteworthy, then, when 3,415 call contracts versus less than 200 puts traded, Trade Alert data show.

The timing of these trades in the July $29 and $30 strike calls before the merger announcement raised eyebrows among some options market watchers. The total bullish options bets in question may have reaped a potential windfall of more than $1 million, or an 1,150 percent gain in eight calendar days.

However, it is hard to pin down whether unusual trading patterns in a target company’s options stems from sources knowledgeable about a pending deal or it can also reflect speculative bets.

"The highly unusual options activity in the days leading up to the announcement indicate that either some traders got extremely lucky with speculative bullish bets or more likely, some traders had an informational advantage upon which they capitalized when shares rallied after the deal was announced," said Gareth Feighery, a founder of options education firm

Owners of calls, contracts which allow them to buy the company’s shares at a fixed price by a certain date, benefit because as the stock rises, the value of the call option goes up. A put conveys the right to sell the stock at a preset price.

Two studies done for Reuters found there are numerous examples of unusually heavy options trading prior to market-moving news.

Just after 1:00 p.m. EDT (1700 GMT) on May 21, when Smithfield shares were trading around $25.63, buyers began lifting offers on July $29 and $30 strike calls, Trade Alert’s Schwartz said.

Nearly 1,200 of the July $29 strike calls appeared to have been bought for 40 cents per contract and 1,500 July $30 strike calls changed hands for 25 cents apiece, according to data from both Trade Alert and Livevol.

The next day open interest on those calls increased by nearly the previous day’s volume, confirming these were new positions. The call buying was unusual when compared to the average daily call volume of 950 contracts over the past 21 trading sessions, Schwartz said.

During Wednesday’s trading, the July $29 strike calls were worth $4.60 per contract and the July $30 strike calls traded at $3.60 per contract, Livevol data show. Based on the volume of those two calls, a combined $85,000 bet would garner more than $1 million in potential profit, said Ophir Gottlieb, managing director of Livevol.

Each call gives the holder the right to buy 100 of the underlying shares.

"This appears to be suspicious call buying with extreme gains in a very short period of time," Gottlieb said.

In an email to Reuters, the U.S. Securities and Exchange Commission, which looks into unusual stock and option trading, declined to comment. A representative for Smithfield declined to comment on the options activity.

A spokeswoman for exchange operator CBOE Holdings said the CBOE’s Department of Market Regulation does review unusual activity on a regular basis but does not comment on specific situations.