An Inside Look At Insider Trading

First of all, I’m sure we’ve all seen the most recent controversy making headlines, which involves Speaker of the House Nancy Pelosi and her husband, Paul Pelosi, who owns a venture capital investment firm.

Now, just last month the House Judiciary Committee advanced the “Ending Platform Monopolies Act,” an anti-trust legislation aimed to curb the power of big tech companies like Amazon (Ticker: AMZN), Apple (Ticker: AAPL), Facebook (Ticker: FB), and Alphabet (Ticker: GOOGL), just to name a few.

And Speaker Pelosi’s husband just so happened to make some very fortuitous trades only weeks ahead of the legislation …

According to a disclosure released last week, on June 18, Paul Pelosi exercised 40 GOOGL call options at a strike price of $1,200.

With the stock trading at more than twice the strike price at the time, the options netted Paul Pelosi what equates to over $4.8 million in profit (now worth over $5.3 million, with GOOGL’s recent share price increase). These calls were originally purchased in February 2020, and, in all fairness, were set to expire on June 18, 2021 (the day they were exercised).

GOOGL between February 20, 2020 and June 18, 2021, courtesy StockCharts

That’s not the only Pelosi trade being given the side eye. In May, Paul Pelosi purchased $1 million worth of AMZN $3,000-strike calls, and $250,000 in AAPL $100-strike calls.

Of course, there’s no actual evidence of insider knowledge, so the Pelosis are likely in the clear, but with all of the stocks involved potentially affected by legislation that Speaker Pelosi has a hand in, it does raise some questions.

The Pelosis are far from the only political figures to come under public scrutiny, but since insider trading is relatively hard to prosecute, it’s not uncommon to see suspect trades slide without action taken.

For example, four Congressional Members were in the hot seat last year after raising suspicions with sudden stock sell-offs just days before the COVID market crash.

Following a closed Senate-only meeting on January 24, 2020 to discuss the effects of the COVID-19 outbreak on the United States, four senators shuffled around millions of dollars worth of their stock holdings, seemingly to shield themselves from losses, and profit from potential COVID-related gains.

S&P 500 January 2020 to July 2020 — courtesy StockCharts

However, investigations were eventually closed on all four members without charges.

Of course, government officials are certainly not the only ones accused of leveraging confidential information to pad their own pockets.

Earlier this year, the husband of an AMZN exec received 26 months in prison for using confidential financial information, given to him by his wife, to make over $1.4 million in profits.

So, not everybody gets away with it …

But how does sneaky “insider” trading affect traders like you and I? 

Well, first of all, it gives select investors an advantage over the rest of us. Besides being inherently unfair, this also arguably erodes broader trust in the markets (after all, if the game is rigged, why play it?) which could make people less willing to invest, and of course, less money in the markets isn’t good for any of us.

But, more concretely, big insider plays can actually hinder our own trading.

For example, studies have found that illegal insider trading can affect the price of a stock, as well as volume and market liquidity. As traders, any of those factors being unfairly and unexpectedly influenced puts us at a disadvantage.

And specifically with insider options trading, huge buy or sell orders of certain options can change the game for the rest of us. It can affect options pricing, bid-ask spreads, the leverage of our trades, and it’s been found that insider sentiment can affect the implied volatility (IV) of options, and skew the call/put balance. Plus, heavy options volume can actually influence stock prices!

Of course, there is the argument that insider trading should be allowed because it means the actual value of a company is more accurately reflected by the market earlier. If “insiders” are allowed to indiscriminately trade after receiving information, the stock price and options will be affected before the news officially breaks, giving investors an early signal of future price trends.

I’m not getting on board with that, but there is something to be said for watching where traders are putting their money. That’s essentially the gist of my gamma radar and order flow technology I use for my Robinhood Trader program. 

It allows me to track where “smart money” is putting their cash, and compare that to what retail investors are doing. I tend to assume “smart money” is actually smart, so it’s to my advantage to know what they’re up to, and when they’re going against the crowds.

However, this is all done on the up-and-up, of course! It just happens to be that I have a proprietary way of synthesizing this information to draw my own conclusions, and make trades off of what I’m seeing.

It’s just a tool to help us retail folks gain our own “insider” advantage!

Your Only Option,

Mark Sebastian

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