Elon Musk’s Twitter Bid, Its Discontents, and How to Insider Trade Like a Professional

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  1. Florida pension fund sues Elon Musk over Twitter deal | Engadget

“The Orlando Police Pension Fund says the deal can’t close until 2025.”

This article caught my eye as I’ve been closely following the ongoing Elon Musk drama with Twitter. It did bring up an interesting topic — what really stood out, without knowing any details, is the push for the deal to not close until 2025.

There are several hypothetical reasons an investor would want this. Let me give one example that will then illustrate how people use this phenomenon to get away with insider trading on Wall Street.

First, imagine you’re the person who just bought a $50 strike call on TWTR that expires in 3 years (2025). Because the option is so long dated, and TWTR is very volatile, those calls are expensive. You might have paid $24.20 for that call.

Now some reckless billionaire comes in and says he will just buy the whole thing in cash for $54.20. You are long calls at the $50 strike and you make $4.20 per call, so everything is good, right? Wrong.

You paid $24.20 per call, so even after your share gain, you are now down $20. What happened here? By Elon taking out the company early and turning your shares into cash, all the volatility premium that was built into the price assuming the company is still around in 3 years goes to zero.

If you were somehow an insider in the position to know this all cash buyout of TWTR was coming, you could use options cleverly to profit.

Let’s take a fictional example. Say you are a security engineer at a large publicly traded crypto exchange. Let’s call this fictional company buycryptoitiscool.com. You have stock in this .com darling. A lot of it.

You grab your 9am Kombucha and log into your secure computer systems at HQ. After a few minutes of staring, you notice an anomaly in the data packets going through an unpatched router that had a recent zero day uncovered.

After some digging, you realize — it’s gone. Not all of it, “just” half the crypto stored in a hot wallet. Blood drains out of your face as you realize the insurance policy doesn’t cover the entirety of the losses, the company is insolvent as a “fully insured” crypto custodian, your customers are going to sue you, and your employer’s reputation is irreparable.

Also, the stock will go to zero and your fully vested shares are soon to be worthless.

You know you can’t immediately login to your private wealth platform and sell all the stock you have. No — that would be incredibly obvious. The SEC learned to monitor for those types of insider transactions a long, long time ago. It’s a huge red flag if the VP of infosec sells all his shares the morning a hack is uncovered and before it’s announced. You’ll get arrested, and that’s a tough noogie.

You can’t go home to your wife and explain how you’re a loser and that there will be no more private yoga classes. Unbearable stuff. So what to do?

Luckily, you read my blog! Listen carefully.

First, login to your brokerage account and watch the options screens. You might see that you can sell call options (overwrites) against the $50 million in buycryptoitiscool.com stock that you have. The options expire in 3 years, so you can actually receive $10 million in option premium, since the calls are so far dated.

Call your wife. Tell her to close on that SOMA penthouse that “we’ve been talking about forever” and we’re willing to pay the $10 million for it, today. If she sounds confused, just find some way to wink over the phone.

Start to cough real loud. Lock your screens and tell your boss you have COVID and need two weeks off. You estimate that that should be enough time for someone else to figure out that the company was hacked and is doomed.

When the news comes out, the stock goes to zero. But — you earned $10 million in premium for the call options, which you obviously sold to fund the purchase of the dream house you and your wife always wanted. You never actually sold a single share so you’re all clear. Yoga classes can resume and you find a new job.

I can probably go on, but I’ve probably gone on long enough. These types of things, while fictional here, have been happening via options on Wall Street for a long time.

This is a set of stylized examples to illustrate what happens when a company’s stock ceases to exist. Going to zero, or being bought out for $54.20 in cash, the outcome is the same — the stock security is no longer around. And folks in finance found out a long time ago how to use options to trade for these types of situations. You will collect the time value from the option of a company that, well, has very little time left to exist! And while doing so, obscure the true underlying information you know.

Nobody outright buys stock right before a merger announcement or sells it before a bankruptcy announcement. Those guys are amateurs. Options are a better option in this situation.

Hedge Funds have much more sophisticated and convoluted ways to structure these types of trades. At banks, we are always on the wrong side of it (since we provide them the liquidity). It’s always a bad day when someone calls you at 3:59pm for a complicated options trade on a FANG stock that is reporting earnings in 30 seconds. But it’s our job, so we do it and lose a ton of money.

There’s really nothing you can do. The client is typically so large and interfaces with so many divisions at the bank, we cannot simply stop dealing with them forever. And it’s nearly impossible for us to prove they were trading on improperly obtained information. They’re too smart to get caught that way.

So what do you do as a trader? You remind yourself this is big boy finance, swallow your pride, and then grab a beer with your colleagues at 5pm.

(Please, if this isn’t already glaringly obvious, this is tongue and cheek — while the concepts are real, I certainly do not encourage anyone to do this)