Proximal Trade definition
Proximal trading, also known as insider trading or tip trading, is an illegal market abuse practice where a trader utilizes confidential or insider information to execute transactions with counterparties who are close in time and space.
Understanding Proximal Trading
In essence, a proximal trade occurs when a trader leverages non-public information to engage in trades with counterparties who have limited access to this information, such as friends, family members, colleagues, or other traders. The trader can exploit this information advantage to gain a profit or avoid a loss on these transactions.
Example of a Proximal Trade
Imagine a trader working for an investment firm who gains access to confidential information about a technology company. The company is about to announce a major deal with another industry player, which could significantly impact the company’s stock price.
The trader, aware of this confidential information before it becomes public, decides to capitalize on this situation by executing trades. However, instead of directly buying or selling the company’s stock, the trader adopts a proximal trading strategy.
The Proximal Trading Process :
- The trader becomes aware of the confidential information that the technology company will announce a major deal in the coming days.
- Instead of directly trading the company’s stock, the trader chooses to buy call options on the company’s stock. Call options give the trader the right to buy the stock at a predetermined price (the strike price) at a future date.
- Shortly before the official announcement and the subsequent stock price surge, the trader exercises their call options to buy the company’s stock at the agreed-upon strike price.
- Once the announcement becomes public and the stock price skyrockets, the trader can sell the purchased shares at a much higher price, realizing a substantial profit.
In this example, the trader has utilized insider information to anticipate the future market movement and employed the proximal trading strategy by buying call options to capitalize on the predictable stock price surge following the announcement. This practice is illegal as it is based on the use of non-public information to gain an unfair advantage over other investors.
