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Knight Trading Soars on Takeover Speculation

Morgan Stanley is mentioned as a possible bidder as Wall Street searches for the next deal.

Updated from 11:53 a.m. ET

Investors tried to step in front of the next big Wall Street deal Wednesday, pinning their hopes on

Knight Trading Group

(NITE)

.

On the same day that

J.P. Morgan

(JPM) - Get Report

agreed to cede control to

Chase Manhattan

(CMB)

, and only two days after

Goldman Sachs

(GS) - Get Report

said it would buy

Spear Leeds & Kellogg

, investors were more than ready to buy into rumors that Knight is next on the list.

Basing their hopes on these deals and the fact that Knight CEO Kenneth Pasternak canceled a scheduled appearance at

Merrill Lynch's

(MER)

financial services conference Wednesday, investors drove the stock up $6.63, or 23%, to $36.06 with 46 million shares traded. Knight options volume -- which often foreshadows M&A activity -- was extremely active, too.

Pasternak's office said he had a schedule conflict, and later Annette Bronkesh, a company spokeswoman, said, "Yesterday at the end of the day Mr. Pasternak saw he had an unexpected business event to attend which conflicted with his panel presentation."

Bronkesh declined to comment on the takeover talk, citing the firm's policy regarding rumors.

Traders buying call options to play the potential appreciation a takeover would bring came early and often to take a shot on Knight. Volume was heavy across the board in the call options, most often bets a stock will rise. September options expire on Friday, making any such plays on Knight extremely short term. Volume in the October options were showing the same kind of pop, with heavy volume and big price increases in the October 35 and 40 calls.

The Jersey City, N.J.-based

Nasdaq

trader is the largest independent market maker out there, after giant houses recently snapped up two of its big competitors. In addition to the Spear Leeds deal,

Merrill Lynch

(MER)

this spring said it would acquire privately held

TheStreet Recommends

Herzog Heine & Geduld

, reversing a trend among large brokerages to make markets in fewer Nasdaq stocks. (Market makers match buy and sell orders.)

That leaves

Morgan Stanley Dean Witter

(MWD)

as the only one of the so-called

MGM

trio (Merrill, Goldman and Morgan Stanley) without a large Nasdaq operation. To

ABN Amro

, that makes Morgan Stanley the most likely buyer of Knight, analyst Robert Napoli wrote in a research note Wednesday. (ABN Amro has done underwriting for Knight.)

ABN Amro put the buyout price at $35 to $40 a share, which, based on this year's expected earnings, would put its valuation on par with what Spear Leeds and Herzog fetched.

Other potential buyers are some of the same names that are popping up amid the M&A frenzy on Wall Street, including

Credit Suisse First Boston

,

Citigroup's

(C) - Get Report

Salomon Smith Barney

unit,

Lehman Brothers

(LEH)

and

Bear Stearns

(BSC)

, Napoli said.

For investors who have sat through some rough days with Knight, the run-up was welcome. The stock is still trading far below its 52-week high of $60.50 but is off its low of $21.69. The stock was hit as investors questioned Knight's ability to keep up its position as the largest Nasdaq market maker, given a decline in the trading of small socks -- its bread and butter -- and the move by Merrill into its business.

Paul Stocking, a senior analyst at one of Knight's largest investors,

American Express Financial Advisors

, said there's obviously increasing interest in market makers. The business allows a firm to closely watch trading, which in turn can help it figure out which way to place bets on stocks.

"The information flow from owning or participating in a market maker is valuable as a standalone business and in other parts of investment banking," Stocking pointed out.

If only there were a little more information and a little less rumor flow about Knight's plans.

Associate Editor Justin Lahart contributed to this story.