New Trade $HLF – Hedgy Stalemate

by Enis February 19, 2013 3:27 pm • Commentary

We first wrote about HLF back in October, when the market was more focused on whether David Einhorn was short the stock or not.  It turned out that Ackman was the big short seller, and since then, a who’s who of billionaires has gotten involved in this story.

The company reports tonight after the bell but the real story is that this has become a situation where the technicals dominate in the short-term, as traders are more focused on where they got long or short, and are trading against that, rather than some long-term sense of value.  Having said that, I do think the low 30’s will be tough to breach on the downside in the absence of significant action by government regulators, as value buyers have shown a propensity to step in there, and the “cheap” argument holds in the absence of government intervention.

On the upside though, you have a large contingent of players who are in this stock for a trade, and Friday’s price action was the most obvious manifestation of that.  Despite Icahn’s best efforts to generate a squeeze, both by accumulating a large position, and then going on TV to advertise it as loudly as he could, HLF stock is only up 10% in the past week.  A hefty gain to be sure, but not as impressive for a stock that has traded between 31 and 47 in 2013.

When I look at the 1 year chart, I see a stock that is bounded in the near term by important support and resistance:  

[caption id="attachment_22825" align="alignnone" width="623"]1 year daily chart of HLF, courtesy of Bloomberg 1 year daily chart of HLF, courtesy of Bloomberg[/caption]


I’ve drawn the red line at the $49 level, and the green line of support at the $30 level, from where the stock most recently bounced.  I would also point out that HLF stock actually traded between 45 and 55 for a good part of 2012, after its May 2012 plunge, well before Ackman released any details about his short position.  So I have a hard time seeing the stock move higher than the low 50’s.

But most importantly, implied volatility in HLF offers good risk/reward to play the range.  Here is the 6 month chart of 30 day implied (red) vs. 30 day realized (blue) for HLF:

[caption id="attachment_22826" align="alignnone" width="656"]30 day IV vs. 30 day RV for HLF, Courtesy of LiveVolPro 30 day IV vs. 30 day RV for HLF, Courtesy of LiveVolPro[/caption]


The spread between implied and realized is now greater than 20 points, and I expect that spread to come in after earnings and a few days of calm with no headlines in the stock.

So here’s the trade:

TRADE:  HLF ($39.79) Sold May 40 straddle at $10.90, bought the May 27.5 / 52.5 strangle for $3.05, collected $7.85 net credit on the structure

-Sold 1 May 40 call at 4.80

-Sold 1 May 40 put at 6.10

-Bought 1 May 27.50 put for 1.60

-Bought 1 May 52.50 call for 1.45

Break-Even on MAY Expiration:

-Profits between 32.15 and 47.85, with max profit of $7.85 with stock at 40 on expiry

-Losses up to 4.65 between 27.50 and 32.15 and between 47.85 and 52.50, with max loss of $4.65 with stock below 27.50 or above 52.50 on expiry


Trade Rationale:   My risk/reward on this trade is about 1.5 to 1 in my favor, and I am giving myself almost 20% room in either direction on the stock before I start to lose money. Even if the stock is volatile, my expectation is that I’ll be able to take this trade off for a winner at some point in the next 2 months.