Why Infosys insider trading allegation may be baseless

A lot of drama surrounded the whistleblower allegation against Infosys ’s top management this month. The stock price crashed and all kinds of rumours were doing the rounds on social media. One particular rumour concerned an insider taking large positions in put options at the strike price of ₹740, before the whistleblower complaint.

Read more:Whistleblower group accuses Infosys CEO of 'unethical practices' to boost numbers

Some sections of the media did stories on this and the market regulator Securities and Exchange Board of India (SEBI) is also reported to be probing the buildup of this derivatives position.

But a closer look shows that these allegations may not have any substance. Put options in Infosys have seen similar sized positions consistently over the last two years. This points towards hedging or some other motive behind the option position and not necessarily insider trading.

It was one particular option contract i.e. November 740 PE, which is the November series 740 strike put option that caught everyone’s eyes.

Why November 740 PE?

It all started with whistleblowers sending a couple of letters to the US Securities and Exchange Commission (SEC) alleging the CEO of “unethical practices”. The first letter was sent on September 27 and the second, a follow-up letter, on October 3. These letters were then sent to the company as well, on September 30. The company released a statement on October 21 saying that it has received anonymous whistleblower complaints and the same has been placed with the audit committee as per company practices.

The stock price of Infosys crashed 16 per cent on October 22, resulting in the premium of 740 PE increasing to ₹103.3 from ₹16.9, a whopping 511 per cent gain in just one day. While the fall in stock price and heavy turnover volumes in derivatives is not out of the ordinary, social media became active about suspicious building up of positions of 740 PE, before the event.

Related news:Infosys: Go short only below Rs 600

On September 25, 1501 lots (amounting to 18 lakh shares as 1 lot of Infosys derivative contract comprise of 1200 shares) were added to the open interest of 740 PE. This triggered a barrage of questions. But is this the first time that unusual volumes have been witnessed in the derivative contract of Infosys? Not really, going by recent derivatives data that is available with the exchanges.

Historical data

On checking the historical data of options contract of Infosys, it is revealed that such buildup of derivatives contracts happens frequently in the stock. On July 16, 1522 lots of OI (18.2 lakh shares) was opened in September series 740 PE. It may be argued that insiders might have gotten hold of the information earlier. But tracing back further, data reveals that on April 16, 1666 lots of OI (20 lakh shares) was opened in June series 680 PE.

A couple of strikes in April series (700 and 730) too had such large positions initiated. But the difference here is that the position was built up in two tranches in each of the strikes. 700 PE saw its OI added by 790 lots (9.5 lakh shares) on Feb 13 and by 931 lots (11.2 lakh shares) on April 12; whereas 730 PE saw its OI increase by 775 lots (9.3 lakh shares) on February 11 and by 368 lots (4.4 lakh shares) on March 26. At some stage the total open contracts in 700 PE was 1721 lots (20.6 lakh shares) and in 730 PE was 1143 lots (13.7 lakh shares).

Such volumes are seen in the previous year as well where the 2019 February series 620 PE witnessed an OI creation of 1336 lots (16 lakh shares) on December 10, 2018. Also, huge positions were built in a couple of strikes in December series. The December series 620 PE and 670 PE witnessed an OI creation of 1241 lots and 1246 lots respectively i.e. nearly 15 lakh shares each.

One difference between the November 740 PE with other options that we discussed is that, in all other scenarios the option expired worthless (exception being 2018 December 670 PE whose last traded price on the date of expiry was ₹12.6) on the day of expiry. In the current scenario, the probability of option expiring deep in-the-money is more i.e. the option will have relatively higher value on the expiry day.

Insider trading

All these data suggest that, one cannot conclude about a potential insider trading purely based on the large open interest in Infosys put options when the whistleblower news was released.

One among many possible reasons for the open interest could be that some large funds are hedging their underlying position in Infosys stock with these put contracts. And as we can notice, the consistency in position size also points towards it being a hedging position.

Importantly, had it been insider trading, the contract would have most likely seen a liquidation, when the premium shot up. But the open interest as on October 30 is still 19 lakh shares. The option has gone deep in the money during the period, increasing the option price multiple times, every reason for any trader to book profit and exit.

Since SEBI has mandated physical settlement of stock derivatives for all stocks from October 2019, it would be interesting to see how the unwinding takes place, if it happens, as the option in question is currently in-the-money.