Questions Surface About Irregular 3Com Options Trading Before HP Acquisition Announced

Questions are surfacing regarding unusual trading patterns in 3Com options ahead of yesterday’s announcement of its $2.7-billion acquisition by HP.

Dow Jones Newswires reports that, under normal circumstances, 3Com’s options are rarely traded, with just a few hundred contracts changing hands daily. On Wednesday, however, 3Com options activity spiked to 13 times the normal volume.

Coincidence? Jon Najarian, co-founder of OptionMonster, said he doesn’t think so:

“Since I do not believe in coincidences on Wall Street, I would bet that these unusual call option trades will spark an investigation.”

As reported by Bloomberg:

Volume in contracts to buy shares of the Marlborough, Massachusetts-based company surged to the highest level since September 2007 before Hewlett-Packard Co. said it would buy the maker of computer-networking equipment for $2.7 billion.

“I don’t believe in that much luck,” said Steve Claussen, chief investment strategist at OptionsHouse LLC, the Chicago- based online brokerage unit of options trading firm PEAK6 Investments LP, and a former market maker at the Chicago Board Options Exchange. “If you’re on the other side of someone buying calls and a takeover is announced, it’s like someone held you up at gunpoint. It’s like you’ve been robbed and you feel violated.”

Call options, conveying the right to acquire stock for a given price by a certain date, usually offer higher returns to traders speculating on takeovers. The Securities and Exchange Commission (SEC) is responsible for policing the options market to discourage and identify insider trading, which — if you think about it, and as Mr. Claussen contends — is a form of larceny.

Regrettably, the SEC apparently wasn’t policing anything yesterday, having been closed for Veteran’s Day.

More from Bloomberg:

More than 8,000 3Com calls changed hands yesterday, 17 times the four-week average. The most active were contracts conveying the right to purchase 3Com for $5 through Nov. 20, followed by December $5 calls. The shares rose 5.2 percent, the most since Sept. 28, to $5.68 in Nasdaq Stock Market composite trading prior to the announcement.

Almost 4,000 of the November $5 calls and 3,300 December $5 calls traded, with almost all of the transactions occurring at noon. That compares with a total of six puts giving the right to sell 3Com shares. Hewlett-Packard, the world’s largest personal- computer maker, agreed to pay $7.90 a share in cash for 3Com, a 39 percent premium to yesterday’s closing price.

More than 22 million shares of 3Com changed hands in the stock market yesterday, compared with this year’s daily average of 4.85 million and the most since March 2008. Trading was heaviest in the hour after 11 a.m. in New York, data compiled by Bloomberg show.

Some have suggested that the call trades might have resulted from “calendar spreads,” in which an investor sells contracts expiring in one month and buys options with the same strike price for a future date. However, that seems unlikely considering that November contracts would not have expired for another nine days.

According to Bloomberg, Goldman Sachs Group Inc. advised 3Com on the transaction and Morgan Stanley served as HP’s agent.

As reported by the New York Times, 3Com is one of several companies that featured in the insider-trading case involving Raj Rajaratnam and the Galleon Group. Traders from Incremental Capital allegedly gained information on 3Com’s previous attempt to sell itself from a lawyer working on the aborted deal with Bain Capital and Huawei, formerly 3Com’s business partner in the China-based H3C joint venture.

The SEC needs to seriously and thoroughly investigate this matter.

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