Whenever we see a successful trade of unusual volume just prior to major news hitting the market red flags are raised. We saw this just as recently as last month around the $23 billion buyout of Heinz (HNZ), when a huge number of call options were purchased just days before the buyout was announced, and this morning the Wall Street Journal ran an article on an interesting trade that Bank of America (BAC) made last year involving Constellation Brands.
The trade took place last June, when the company's trading desk made an aggressive wager that Constellation Brands would trade higher. Bank of America's trading desk bought a large amount of calls on the stock, pushing the daily volume to 13 times its 30 day average.
While big trading desks like Bank of America are always placing big bets, what makes this one stand out is the news that came to light just one week later. At the time the trade was placed, Constellation was a 50% owner in the Mexican beer maker Crown Imports. One week after Bank of America bought its call options on Constellation the company announced a pact with AB InBev to buy the remaining 50% of Crown Imports.
The news immediately sent Constellation stock higher, and not just a little higher. On the day the deal was announced, Constellation stock shot up a massive 24%. Needless to say, Bank of America made a nice profit on the deal.
What makes the Bank of America trade even more suspicious is the fact that the bank was part of a duo of companies that helped to finance the Crown Imports deal. The company has issued a statement that it maintained a “Chinese wall” between its different units to make sure information was not flowing back and forth and eventually hitting the trading desk, but if there was no wrong doing, then this would be a case of extreme coincidence.
Bank of America has defended the trade by saying that at the same time it was buying calls on the stock it was also betting against the company. It claims that it was basically wagering that the stock would stay flat. The problem is that the wager on the stock moving higher was much bigger than the other side of the bet.
Perhaps this is just a case of a great timed trade, and the connection between the trade and the bank's role as funding the deal is just a huge coincidence, but it does highlight an underlying problem on Wall Street. How can we ever put 100% trust in companies that are able to not only orchestrate major deals while at the same time benefit from the knowledge ahead of time? The answer is, we can't.
Disclaimer: At the time of this article Mr. Fowlkes has a long position in Bank of America.