Insider trade on Splunk acquisition?

Can someone explain the mechanics of this specific trade to a noob? The trader bought 550k options yesterday for SPLK to hit $127/share? Since that seemed highly unlikely they were only priced at $.04 each. but now that SPLK is at $145/share they are worth $18 each? so that would be a profit of ~$10m?

Yes. The one bit you’re missing is that a call option is the right to buy a stock at a certain price typically on or before a certain date.

To make the numbers simple, imagine a stock trades at $10/share. If someone came to you and said: how much would you be willing to pay to have an option to buy the stock for $100/share? The correct answer is: it depends. If it’s the right to buy the stock for $100/share at any point over the next 10 years then that’s worth more than to buy the stock at $100/share in the next day. A stock trading at $10 is unlikely to jump to $100 in a day so the option to by it for $100 is not worth much. It could happen, so it’s worth something. But it’s unlikely. So, again to make the numbers simple, let’s say it’s worth $0.01/option to buy a stock at $100 in the next day when it’s trading at $10 today.

Now imagine it’s the next day and the company with the $10 stock discovers the cure for cancer or invents time travel or perfects cold fusion. News breaks and now it’s trading at $1,000 per share. Now how much is the right to buy the stock at $100 per share worth? The answer is going to be something really close to, but maybe a small discount from, $1,000 (current value of the stock) - $100 (how much you pay based on the option) = $900. So what was worth $0.01 yesterday is worth $900 today.

Let’s say you have $10,000 to invest. If you know in advance the news is going to break you can do two things to (probably illegally) try and profit from it.

1. Buy 1,000 shares of the stock for $10/share. 2. Buy 1,000,000 options to buy the stock for $100/share tomorrow with each option costing $0.01.

With strategy 1 you spend $10,000 to buy something that, after the news breaks, is worth $1,000,000. Not bad. But with strategy 2 you spend $10,000 to buy something that’s worth $900,000,000 after the news breaks.

In both cases you’re likely to at least be investigated. And strategy 2 seems especially suspicious because the risk is so high and the non-illegal reasons for doing it are so few and far between. Very few reasons you’d buy a bunch of call options that only pay off if something causes a stock to move dramatically in 24 hours.

Finally, while short-dated, out-of-the-money call options are not something many if anyone should be playing with, they’re just a different flavor of something very familiar. To put it in context a lot of HN readers will understand more intuitively: a call option is what you often receive when you get equity in a startup. It’s the right to purchase shares at a price (strike price) before a certain amount of time (typically 10 years).

This is great, and as good a place as any for the thread to sprawl from, so I'll ask: it depends on how you know the stock is going to shoot up the next day, right? Trading on private information isn't illegal, and there's a huge variety of ways to acquire private information at varying levels of confidence, and in a sense the purpose of the markets is to aggregate everyone's private information to estimate a price.

So a scenario I'm curious about:

Say you're, like, an employee at DataDog, and you're involved in a long-term M&A discussion with Cisco that you know is competitive (I've had the pleasure of witnessing one of these at Arbor Networks). Things are looking great, you've picked up a bunch of strong signals that Cisco is definitely going to make a move, and then: the talks fall apart.

Knowing Cisco, you immediately reach the logical conclusion that they're about to acquire your biggest competitor.

You have no fiduciary duty to Splunk whatsoever. Cisco is, if anything, hostile. Buying Splunk options that are valuable only if Cisco acquires doesn't impact DataDog at all.

Have you violated insider trading laws if you buy the options?

Think the super unsatisfying answer is:

¯\_(ツ)_/¯

I think a lawyer would advise that that trade would come with a ton of risk. But the law isn’t clear. Generally, the SEC’s goal is to make sure markets are “fair.” What makes a market fair is hard to define.

If you do a ton of work to launch satellites to fly over Walmart parking lots and then model the correlation of how full they are to what the company’s next earnings will be: that seems like you worked hard and earned an edge you can trade on without getting in trouble. Feels like anyone has a theoretically equal opportunity to do the same work you did and get the same trading edge. That feels fair.

Your hypothetical feels less fair. Is it unfair? Maybe? So unfair that it’d be prosecuted? Probably depends on a number of things, including how much you made on the trade. At a minimum it’s an area of unsettled law. And you would almost certainly be in for serious scrutiny and a legal fight.

Supposedly one idea for Google’s business model early on was that they should use search query data to trade equities. After they researched it they concluded it would be considered insider trading. Though it’s hard to distinguish from overhearing something on the train, which (not legal advice) generally has not been. Think the difference at some level is scale and intention. And, I’d guess, if you made it your business to ride the Acela every day between Greenwich and NYC, bought special hearing aides that let you better eavesdrop on conversations, and made significant profits trading on the information then you’d be more likely to be successfully prosecuted.

But… how is that different from flying satellites over Walmart parking lots?

¯\_(ツ)_/¯

Sometimes the law is intentionally a bit unclear. Usually in areas like this where you care about a general concept of fairness and want some caution and buffer at the margins.

So since you mention Wal-Mart. They have, probably, a better idea of Proctor&Gamble's quarterly sales than anybody but P&G, right? Like Walmart makes some massive double digit percentage of sales of p&g products, and knows about it possibly in real-time. If I was some data analyst at Walmart,I couldn't trade on that, that's misappropriation. But Walmart could potentially spin up a hedge fund and trade (against) their suppliers, until their suppliers threaten to pull product, I think?

Presumably there's a contract between Walmart and p&g that they won't trade in each other's stocks, specifically to prevent this?