Hypothetical Dual-Gamble

[RocketManJames]

Hypothetically, would this be legal? Would it even work?

Say we pick out a fairly low market cap casino stock... something like MTR Gaming (mkt cap: ~200MM).

Their quarterly profit is around $6-7MM.

Say you had a lot of money, and say you were able to make large bets. I have no idea if this would be allowed at such a small place.

If you were able to somehow lose a decent chunk to them (say ~$3MM), would it be considered trading on inside information, if you went and started buying a ton of stock?

If you somehow managed to win a bit, then no need to take the 2nd gamble and buy stock, instead just keep the winnings.

Totally hypothetical, and I haven't thought it through much, but I was thinking that if you were able to do this slightly before they closed the books on the quarter, then you would probably be able to hold on to your newly bought shares until the actual earnings announcement that would surely have a significant upside surprise.

Any thoughts appreciated.

-RMJ

It wouldn't be illegal. You're not an officer of the company, and you have no obligation to keep your knowledge secret. If I crack open my Ipod and discover it contains plutonium, it'd be fine for me to short Apple. The scheme might not work as well as you think. Here are some issues:

1. In a simple version of the stock market, the 3 MM gets distributed equally among all shares. So in order to recoup half of that, you'd have to own half the company. You're probably hoping that the rising earnings will push the market cap up much more than 3 MM. This may not happen, and in fact it could even cause the stock to go down. It depends on how the company handles the windfall. If they make up a good story about how their new advertising strategy is increasing revenue, the market might believe it. If they're more honest and say that the growth was almost entirely due to a single big-time gambler, there will be little interest from the market. The revelation about the potential volatility of the earnings might push the stock down (if you lost $3 MM, there's a good chance you might win 3 MM next quarter).

2. However the market handles it, in order to offset your losses, you'll have to buy a big chunk of the company. For most small-cap stocks, there's relatively little liquidity. As you buy more than, say, 1% of the company, the price of the stock will rise quickly. In most takeover bids, the buying entity offers 30-50% above fair market value for the target company. You're not buying the whole thing, but you'd have to buy at a fairly large premium. Then when you want to sell 2 weeks later, you'd push the price down artificially and sell at a discount.

If you intentionally lost 3 MM, you would not be able to turn that into a profit using this strategy. If you bet 3 MM on a single hand of baccarat, and either pocketed the winnings or used this stock strategy as insurance, you might be able to make it slightly +EV.

[RocketManJames]

Ya, I was looking at it much more as turning a slightly -EV bet into a +EV one where there was a "bonus" payback if you lost.

It'd be really hard to pull off as you said, but I just thought it was a neat thing to think about.

-RMJ

[BradleyT]

That is pretty neat but like Aviva said they'd have to have "something" else like a 50% increase in players through the door or a 50% increase in amount wagered per player for the market to really react.