But that still doesn't explain everything.

By Stephen Gandel
June 14, 2016

Even the sighting of an iron condor can’t prove that there wasn’t insider trading in the run up to the Microsoft msft deal to buy LinkedIn for $26.2 billion.

Yesterday, Fortune pointed out that there seemed to be some pretty weird options trading of LinkedIn lnkd shares in the days before the deal was announced on Monday. Our guess was that someone was very lucky or that it was another case of insider trading.

In fact, a number of people pointed out that something else could have been going on.

The number of call options, a hyper-charged way to bet that a company’s shares will go up, spiked on Friday. And they were the type of call options—short-dated and so-called out-of-the-money, meaning they would be profitable if the price of the shares suddenly spiked—that usually signal someone knew something they shouldn’t have. But what we missed is that the number of put options, which are what you buy when you are betting the prices of a stock will fall, purchased also spiked on Friday. Here’s the call option volume chart we put up yesterday:

Here’s a chart of the put volume over the same time:

As you can see, there is a similar spike in buying (and selling) of put options on Friday. What does this mean? It’s not clear. But one guess is that the person or persons buying puts didn’t have any information about the merger, but was instead engaging in a complicated trade called an iron condor. (It is impossible from trading information alone to know who the buyer of the options was.)

An iron condor is when you simultaneously buy and sell call options in a tight spread somewhere above where the stock is trading, while, also simultaneously, buying and selling put options in a spread below where the stock is trading. In this case, it appears four trades were made at the exact same time—a call spread between $160 and $180 and a put spread between $115 and $125.

But here’s the thing about an iron condor trade, you want nothing to happen. The way you make the most money is if the stock price stays within the inner spread you have created, in this case between $125 and $160. It’s not as good if the stock ends up outside the outside range, either below $115 or above $180.

But in a well constructed iron condor, you should still be okay. The mix of put and call collars is supposed to support you in extreme situations—the so called wings of the iron condor, where the trade gets its name from. Generally, the worst thing that can happen in a properly constructed iron condor is for the stock to land is outside your inner spread, but inside your outer spread, which in this instance is between $115 and $125, on the low side, or $160 and $180, on the high side. But that is not what happened here.

It turns out that the trader who built this iron condor didn’t do such a great job. For an iron condor to work out you need the stock price at the start of the trade to be in the middle of the range. That wasn’t the case here. At the time of the trade, LinkedIn’s stock was at $132, which was only $7 above than the top of the iron condor’s lower spread, but $28 below the top spread. The result was a sort of lopsided trade. If the stock rose, the two puts at the bottom of the trade would lose more than the two calls at the top of the condor would generate. This may have been by design.

There’s a name for this uneven options trade as well, a broken wing condor, which in this case was particularly injured by the fact that LinkedIn’s stock took flight the following trading day. Here’s how it ended up playing out:

The profit flight of the LinkedIn Iron Condor.
MKM Partners

The projected profit or loss from the trade is on the right hand side y-axis. At the current price of LinkedIn’s shares, which have risen to about $191, the four-part options trade is projected to produce a loss of $1.2 million.

But here’s the real point: If this is the trade that the person who caused the spike in the calls on the Friday before the Microsoft deal was announced was trying to put on, it wasn’t insider trading. That person clearly didn’t think a deal for LinkedIn was coming, because this is the exact opposite trade you’d want if you think LinkedIn is about to announce a major deal that will send its stock soaring.

None of this, though, excludes the possibility of insider trading. An iron condor, even a broken one, can not explain why someone, perhaps even the same person, separately bought $175 calls in the last five minutes of trading on Friday, which generated a trading profit of $500,000 in less than a day. Nor does it explain the 2,502 call contracts that were bought on May 31, a trade that has now made roughly $2.7 million in about two weeks.

And the iron condor explanation has a problem as well, namely that even if the trader didn’t know a deal was coming, it was a pretty dumb trade anyway. The options are set to expire in mid-August, about two weeks after LinkedIn is set to report its second quarter earnings. Even if there was no deal, those earnings would likely cause some volatility in the social network company’s stock price.

After LinkedIn’s first quarter earnings, the stock dropped 40%. Of course, buying out-of-the-money calls just days before a deal is announced on insider information is a pretty good recipe for going to jail. So given the two options, the money losing broken wing, iron condor may have actually been the smarter one.

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