Luck, Genius, or Insider Trading? Cisco's Splunk Deal Sparks 45,000% Overnight Gains

On Thursday, September 21, US technology giant Cisco made waves by announcing its ambitious plan to acquire the cybersecurity software company Splunk (SPLK) for a transaction value corresponding to $157 per share. This marked a healthy 31% premium over Splunk's recent closing price and translated to a substantial $28 billion in equity value. This strategic move, the largest in Cisco's history, is designed to synergize the strengths of both companies, particularly in artificial intelligence, security, and observability software, thereby strengthening its cybersecurity service offering.

The announcement sparked a substantial 20% surge in Splunk's share price.

This share price increase proved exceptionally fortunate for an astute trader who, on Wednesday, September 20, had taken a $22,000 USD gamble on Splunk call options. After Cisco's acquisition announcement, the share price surged on the morning of Thursday, September 21st, resulting in an astonishing $10 million profit from those call options. This staggering return on investment, an astronomical 45,000%, has inevitably raised eyebrows, prompting speculation about potential insider trading activities.

To understand how it is possible for a trader to yield a 45,000% percent return in such a short time, we should familiarize ourselves with the workings of call option trading, as these were the type of options held by our notorious (and now prosperous) trader

In short, a call option is a contract between a buyer and a seller (often referred to as a market maker) that grants the buyer the choice, without the obligation, to purchase an underlying security, typically a publicly traded company's stock, at a predetermined strike price at a later date, in exchange for a specified option premium.

Unlike traditional stock holdings, where returns are based on the difference between entry and exit prices, call options offer the potential for significantly higher returns because of the use of leverage.

There is no better instance of such a possibility than the subject of this article; the aforementioned trader was able to buy 550,000 call options at a strike price of $127 on Splunk, trading at $120 at the time of the trade (Sept. 20th) for 0.04$/option, while being able to profit about 18$/option, a 45,000% return, the stock had risen to about 145$, 18$ over the strike price. If the trader had instead simply bought and sold common shares of Splunk (SPLK) over the same time period, he would have yielded a “measly” 20% return.

Call options are a very interesting derivative product to use, since it gives the investor a possible enormous return due to leverage, while the loss is limited to the premium paid. With a considerably low probability of the option ending up in the money within such a short time frame, the situation with the Splunk trader definitely put him in the spotlight.

Of course, this case is particular and to take with a grain of salt. It is highly unlikely for any company’s share price to surge 20% overnight without any major changes. The aggressive price increase was much the result of the early morning intention to merge announcement from Cisco to acquire Splunk, something which apparently no one saw coming but the trader in question.

Now, before we get into details, what exactly is insider trading? Insider trading­­­­­­ is when an individual trades a stock for a public company based on confidential, non-public information. Insider trading involves using privileged information for trading that is not available to the general public, often resulting in unfair advantages and violations of securities regulations. Insider trading is dangerous for the dignity and honesty of financial markets. Hence, certain laws and regulations were implemented in Canada and the United States to condemn this type of trading. However, both countries regulate financial markets in different ways.

In Canada, regulations are largely driven by provincial or territorial laws, and applied in consideration to the jurisdiction’s securities commission. In other words, Canadian provinces all have their own organizations regulating their companies. These provincial and territorial organizations form one umbrella organization named the Canadian Securities Administrators (CSA), whose objective is to “improve, coordinate and harmonize regulation of the Canadian capital markets''. Note that the CSA acts more as a support for provincial organizations. Canadian public companies also need to comply with the Canada Business Corporations Act (CBCA), which regulates Canadian business corporations.

In the United States of America, the Securities Act of 1933, is the law on which organizations will base themselves to regulate financial markets. The Securities Act has two primary objectives. It requires that investors get access to all the information that’s necessary concerning publicly offered securities, and it “prohibits deceit, misrepresentations, and other fraud in the sale of securities”. This law is guided by the renowned Securities and Exchange Commission (SEC). In contrast to Canada, the SEC is responsible for the entirety of capital market regulations in the US, with the states and territories taking a secondary role in the process. The Securities Exchange Commission states that individuals who engage in insider trading may be sued civilly either by the SEC itself or by private litigation organizations. They may also get charged for criminal violation. In addition, the SEC Rule 10b-5 from the Securities Exchange Act (1934) prohibits insiders from using privately held corporate information to reap greater returns or avoid losses on a company’s stock. With that said, it seems clear that the insider profiting from the Cisco and Splunk situation trespassed regulations.

Result of luck or use of privileged information ?

Even if the law is clear, many cases of insider trading are still reported. Acknowledging someone realizes a significant profit utilizing privileged information, it isn’t hard to understand why insider trading is prohibited, he has an unfair advantage over all the other investors. This type of behavior is against the integrity of the financial markets. This makes us wonder, is the lure of profit worth the possible criminal charges?

Capital Markets Team - Equity Research