Wednesday, September 4, 2013

Rochester Medical (ROCM) - Cheater? Pre-Takeover Option Trading Looks Suspicious. How to Make 145% in a Week on 2,300% Daily Average Volume

ROCM is trading $19.95, up 44.46%. The LIVEVOL® Pro Summary is below.

Rochester Medical Corporation develops, manufactures and markets a range of polyvinyl chloride (PVC)-free and latex-free urinary continence and urine drainage care products for the extended care and acute care markets.

I found this stock with a simple scan: The top stock gainer on the day. The news pushing the stock is pretty straight forward:

“C.R. Bard (BCR) has agreed to acquire Rochester Medical Corporation (ROCM) in a cash deal worth approximately $262 million. Under the terms of the deal, each ROCM shareholder will receive $20 per share. The deal is expected to close during the fourth quarter of 2013”

While the news is straightforward, unfortunately the trading pre-takeover news is not quite so straightforward. This one looks like another potential case of insider information used to garner an unfair (and illegal) gain. I’ll lay out the evidence and let you make your own conclusions.

Let’s start slow. I have included the Stats Tab, below.

Two things I want to focus on:
(1) The total average daily volume over a three month period in options is ten contracts. Yeah, ten. On average that settles into one put and nine calls.

(2) The average open interest (OI) over the same three month period is 407, which breaks down into 247 calls and 160 puts.

OK... Now let’s turn to the Options Tab.

I have highlighted the Oct 10 calls which show an OI of 263 contracts. Since the average OI over the last three months (247) is below that number, my eyes popped a bit when I saw the 263 number. But, that’s still just a number…

Then I looked at the open interest chart for just that call. I have included that image below.

Here’s where it starts to look a bit suspicious in my opinion. On 8-28-2013 (so five trading days ago), the OI in those Oct calls went from 33 to 263. That means 230 of the Oct 10 calls traded when the firm averages 9 calls a day and a total (all encompassing) call OI of just 247. Hmm….

OK. More evidence?... Sure… 8-28-2013 (the day those calls were purchased) was the largest option volume day over the last-years in ROCM (I don’t have access to data more than two-years old right now), so in English, the volume on the day was in fact the highest over a multi-year window.

The next step was to look at those trades more myopically. I have included the Time & Sales tab below.

We can see that 230 of the Oct 10 calls traded for $4.10 with the stock closing at $13.86. The NBBO was incredibly wide b/c of the low volume in the options but we know the calls had $3.86 in parity ($13.86 - $10). The Oct 10 puts had no bid, so a $4.10 price in the calls priced the puts at $0.24. That feels like a purchase to me (lest we forget put-call parity).

At $20 per share (the deal price), those Oct 10 calls are worth $10 (at least), which makes a $5.90 gain on a $4.10 bet or a 145% gain in a week originating from the largest option trading day in two-years on call volume 2,300% the daily average volume.

OK, your turn to draw a conclusion...

This is trade analysis, not a recommendation.

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