Chart of the Day – $HLF, Ackman, and the Options Market

by Enis December 20, 2012 1:13 pm • Commentary

Herbalife has dominated the headlines in the past 24 hours after Bill Ackman disclosed that he was short HLF, and that it was one of the best short opportunities he had seen in years (he is currently presenting his thesis at the Ira Sohn conference in New York).  The story took an especially interesting twist yesterday afternoon when the CEO of Herbalife appeared on CNBC, and blasted Bill Ackman for market manipulation (video here).

What most fascinated me was the Herbalife CEO’s comments on the options market.  His exact words:

This is blatant market manipulation.  This appears to be another attempt to illegally manipulate the market by a group of short sellers.  Here is what we know…An extraordinary number of puts in our stock were due to expire this Friday.  We previously learned this activity was pegged at some kind of, quote, significant event.  Mr. Ackman suddenly announces he will make a presentation on Herbalife on Thursday, the day before the puts expire.

WOW.  A CEO citing his own stock’s options market.  I’ve traded options for many years, and I’ve never heard a CEO explicitly talk about his stock’s own options contracts in this manner.  Ackman responded that he is only short the stock, and has not engaged in any put options trading (Reuters article here).

The first thing I did when I heard the CEO’s claims was check the options activity in Herbalife over the past few months.

Here is what I found.  A big initial chunk of activity occurred in late October, early November (with HLF stock trading between 48 and 53), in 3 different December put option contracts:

1)  The Dec 47.5 puts were the most active, with open interest of almost 10k.  The chart below shows the price of the puts on top, and the open interest of this option line on the bottom.  You can see that the open interest went from essentially 0 to almost 9k between Oct 30th and Nov 5th, likely one large buyer paying between $3 and $5 for those puts:



2)  The Dec 45 puts also have open interest near 9k.  One chunk was bought in late Oct, early Nov, with another chunk trading in late Nov, as shown by the open interest line in the lower chart:



3)  Similar story for the Dec 42.5 put.  One initial block around Oct 31st, Nov 1st, then another block in late Nov:



So I’m relatively confident that one large buyer bought the first chunk of Dec 47.5, 45, and 42.5 puts in late Oct, early Nov.  What to make of the second chunk of trading in late Nov?

That’s where it gets even more interesting.  A lot of incremental buying of Dec puts occurred on Nov. 28th, based on the increase in open interest and the increase in options prices (not just the 3 lines mentioned above, but even the Dec 35 or Dec 37.5 puts for example had a lot of buying).  But on Nov 29th, HLF broke $45 intraday, and tested 1 year lows around 42.15, only to bounce in the afternoon.  During that bounce, there was a massive seller of Dec and Jan13 puts.

The large buyer of Dec puts had driven up the implied volatility of all HLF options as a result.  If I owned a large chunk of Dec puts in a high volatility name like HLF, I would be looking to lock in some gains if and when the stock had a mini-swoon.  But instead of selling the puts I was already long, I might decide to spread them against lower strike puts in Dec and Jan13, to take better advantage of the higher implied volatility while keeping my short delta position.

That is my hunch as to what happened on Nov. 29th.  Here is what I wrote in the Too Many Options post with regards to HLF options activity on that day:

HLF – IV30 is in 25 points today with lots of sellers in the puts, mostly Dec and some Jan’13.  74K+ options traded today, versus an average of 7000.  Stock traded as low as $42.18 today, but is back above $45.  Vol had spiked up with put buyers the last couple of days and speculation was that some sort of announcement must be coming soon, maybe with the FDA.  I’ve not seen any news to explain either the put buying, vol spike or the turn around.

The large buyer might have locked in some premium on that Nov 29th intraday selloff, and held on to his higher strike Dec puts, mitigating his time decay in the interim.

As we sit today, the upside Dec 47.5, 45, and 42.5 put trades are big winners, and many of the lower strike Dec and Jan13 puts that traded on Nov 29th that were likely sold are actually close to flat.  We don’t know the identity of the large put option trader in HLF, but it seems that they’ve traded the name quite well.

This is all pure speculation on my part.  But the options prices and open interest tell an intriguing story.  I am very interested to see how open interest in Jan13 moves from here, as the Dec options expire tomorrow.  Fascinating stuff.