New Trade $HLF: A Small Hit of Herb

by Dan January 17, 2014 2:50 pm • Commentary

Yesterday we highlighted some unusual options activity in HLF over the last week (Big Options Activity Looking for Herb to Get Smoked) that has led many market participants to speculate that a certain known short in the stock has up-sized his position.   From yesterday’s post:

we’ve seen a flurry of activity in the Jan15 50 puts in HLF.  First, on Thursday, January 9th, the Jan15 50 puts traded 25k times at 7.25 (mentioned in our Friday TMO post).  The same line traded another 20k times at 7.10 on Friday, January 10th (also mentioned, in our Monday TMO).  The Jan15 50 puts now have the most open interest of any strike in HLF, at around 50k in total.

The HLF story caught some new attention soon after the put purchases as Chinese regulators have launched an investigation into alleged pyramid schemer NUS in China, causing the stock to crater 44% this week alone. Given HLF’s reliance on future growth in China (currently about 10% of their revenues, but growing year over year off of a very low base at more than 50%) investors have shot first and decided to ask questions later, resulting in a 15% decline so far on the week.

Aside from the options activity, the technical set up in HLF is also very interesting.  The one year chart below might as well have a target on the stock’s 200 day moving average (yellow lined and circled) at about $60, which also corresponds with a massive technical support level going back 3 years!

HLF 3 year chart from Bloomberg
HLF 3 year chart from Bloomberg

As we highlighted in yesterday’s post, implied volatility in the stock is back near the one year highs after the long dated out of the money put purchases last week caused a huge spike. Enis noted:

Despite the rise in HLF stock, 1 year implied volatility has remained near its highs.  Last week’s activity in the Jan15 50 puts took place for elevated premium as a result, with a break-even on those puts of around $43, almost 50% lower from the stock’s recent all-time high set at $83.51 last week.

The one year chart of implied volatility (below) demonstrates the recent move, but also suggests that the margin for error on long premium directional trades is fairly narrow as any cooling in the story will see IV come in at least 20 points, thus causing the prices of options to basically melt!

HLF 1 yr chart of 30 day at the money implied volatility from Bloomberg
HLF 1 yr chart of 30 day at the money implied volatility from Bloomberg

It is my view that Ackman will eventually be right, (although it could be a Pyrrhic victory  at that point) and it’s just a matter of if and when his views will ever be shared by regulators in the U.S.  For those who agree and think Ackman might have finally right-sized his short position in a manner that gives him some time to see the story unfold, and also think the news flow might have turned, causing opportunistic longs with big gains to re-think their position given NUS’s decline, then here is a way to play for a move lower to the $60 support (that looks like it should be a magnet on the downside) as well as a play for a vol crush once the news flow settles:  

TRADE: Bought the HLF ($71.10) Feb 70/60/50 Put Butterfly for $1.50

– Bought 1 Feb 70 Put for $7.05

– Sold 2 Feb 60 Puts at $3.72 each ($7.44 total)

– Bought 1 Feb 50 Put for $ 1.89

Breakevens on Feb expiration:

Profits: btwn 68.50 and 51.50 make up to 8.50, with max gain of 8.50 at 60.

Losses: losses of up to 1.50 btwn 70 & 68.50 and btwn 51.50 & 50 with max loss of 1.50 below 50 or above 70.

Trade Rationale:

This is clearly a short biased trade, and a fairly inexpensive one at that. If the stock were to sell off even a few dollars it would then be taking advantage of the sky high premiums to set up a wide range for profitability between now and Feb expiry.  The trade won’t make a lot of money immediately, even if HLF heads lower right away, as it depends on both a lower stock price and lower volatility.  But given the risk/reward and the situation in HLF, we especially like this structure to play for a move to 60 in the coming weeks. The bid/ask in this trade is very wide so this is not something you want to chase. I put my bid well off the ask (nearly mid market) and got filled.