Thursday, November 1, 2007

Sell on the Dip

There is an investment adage to "buy on the dip," meaning that when the stock market has one of its periodic one-day plunges that appears to be irrational, buy shares to take advantage of the discounted prices.  If you know bad news is coming, you can also position yourself to take advantage of it, and two SEC insider trading cases show once again that investors can profit from impending bad news just as easily as good news.  In one case, a former vice president at mortgage lender Countrywide Financial took advantage of information about a quarterly earnings shortfall by selling out his shares, sold short additional shares, and bought put options.  The stock dropped 11% on the announcement, netting profits and losses avoided of $35,547.93.  According to the SEC Litigation Release (here), in addition to the disgorgement the defendant paid a double-penalty, a steep price for a single set of trades.

In a second case, the Commission alleges that a Ukrainian national made bearish trades in IMS Health Inc. before the announcement that the company missed its quarterly earnings mark.  The SEC Litigation Release (here) states:

[J]ust hours before the close of the market on October 17, 2007, Dorozhko, while in possession of material nonpublic information regarding the impending announcement of negative earnings by IMS Health, purchased 300 Oct 25 out-of-the-money and 330 Oct 30 at-the-money put options on the common stock of IMS Health which would expire on October 20, 2007, just three days later. According to the Complaint, after the market closed on October 17, 2007, IMS Health reported third quarter earnings of $0.29 per share, which was 28% below analysts' consensus estimates of $0.40 earnings per share and 15% below the previous year's third quarter earnings of $0.34 per share. The Commission alleges that on October 18, 2007, IMS Health's stock price fell to a low of $21.20 per share or 28% from the previous day's closing price. On the same date, Dorozhko sold all of his IMS Health put options and realized proceeds of $328,000 and profits of $287,346 according to the Commission's Complaint.

Because of the overseas trading, the Commission sought and obtained a freeze order to keep the money in the United States while the Enforcement Division staff completes its investigation. (ph)

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