Thursday, November 12, 2009

Call options and insider trading

My students know that options provide leverage. You don't have to exercise the option to profit, you just need to hold a call option while the stock price goes up. Your gain will be from the increase in the value of the option. My students also should know that insider trading is the practice of making trades based on private information.

So knowing all this, if you knew that HP was about to launch a takeover of 3COM, what would you do? Answer: buy calls on 3COM of course.* Turns out that's what a lot of people did.

*assuming you were willing to risk breaking the law.