Name That Trade – $HLF: If I Had Billion Dollars…..

by Dan March 3, 2014 3:43 pm • Commentary

Back in mid January there was some unusual options activity in HLF that led many to believe that it was Pershing Square’s Bill Ackman levering up his well documented short position.  To refresh we highlighted the activity and our thoughts below on Jan 16th, but here was the activity:

on Thursday, January 9th, the Jan15 50 puts traded 25k times at 7.25.  The same line traded another 20k times at 7.10 on Friday, January 10th   The Jan15 50 puts now have the most open interest of any strike in HLF, at around 50k in total.

The Jan15 50 puts is now the single largest strike of open interest while the next two largest are the Jan15 60 puts with 29,000 open and the Jan15 65 puts with 23,000 open.

Since the company raised $1 billion through a convertible offering a few weeks ago and used much of the proceeds to buy back its own shares the stock has traded sideways to down and frankly feels like it is out of steam despite short interest remaining at a fairly staggering 30% of the float.

The stock caught my attention on a day that fellow multi-level marketer NUS is down 12% after offering a disappointing Q1 forecast.  While NUS does not appear to be a battle ground stock between 2 large hedge fund titans like HLF (Ackman short and Icahn who is the largest shareholder with almost 17% of the shares outstanding) it does appear that there may not be too many new incremental buyers of these companies, especially if the often overlooked fundamentals of these companies/business models begin to deteriorate.

I would also add one more point about HLF, it seems that the management and the activists on the long side have been hell bent on squeezing a much despised short seller, but at this point I am not sure how many bullets the company has left, as they chose to use much of the proceeds of the convert for an accelerated buyback and while there were talks of the company being taken private I would assume that is very unlikely after the company just levered up to buy back their own stock.

I could be a bit nearsighted on this one, but it would appear to me that if Mr. Icahn who already has massive gains in his long position were to liquidate, this stock would likely find itself very near the put strike that Mr. Ackman probably owns a lot of at $50.

If I were Mr Ackman and thought HLF was a ponzi scheme I would look for further ways to lever up my short thesis with defined risk, as it appears he might have done in January. One such way to do this would be to buy long dated one by two put spreads that has no tail risk.  What does this mean? Let me lay out the hypothetical trade and explain:

Hypothetical Trade: HLF ($65.10) Buy the Jan15 50/25 1×2 Put Spread for 5.00

-Buy to open 1 Jan15 50 Put for 9.30

-Sell to open 2 Jan15 25 Puts at 2.15 each or 4.30 total

Break-Evens on Jan15 Expiration:

Profits:  between 45.00 and 5.00 make up to 20.00, maximum gain of 20.00 at 20.00

Losses:  lose all 5.00 at zero or above 50.00, lose up to 5.00 btwn zero and 5.00 or btwn 45.00 and 50.00

Rationale:  From a risk reward standpoint this trade does not look too much different than a straight 50/25 put spread, except I have lessened the cost by about 25%, while the potential reward would only be 10% greater, BUT I have also given myself a wider range to make the dull potential profit while reducing my potential loses on the upside.

So the main point here is that you would only does this to lever up an existing bearish view, or that you had a lot of conviction that the stock would be much lower over a defined period of time.  Also Mr. Ackman has already demonstrated that he is willing to buy well out of the money premium to express his short view, this structure offers a fairly healthy risk /reward if you are of the belief the stock could be down at least 30% in the next 11 months.

This is not a trade that we are doing, as we do not share Mr. Ackman’s conviction on the idea, but If I had his conviction I would look to be as creative as possible to add leverage to thesis, and this would be one way to do so with defined risk.



Original Post Jan 16th, 2014:  $HLF – Big Options Activity Looking for Herb to Get Smoked

Bill Ackman has been designated the Big Loser in the HLF battle with Carl Icahn last year. HLF hit a new all-time high in late 2013, less than a year after Ackman first laid out his short thesis on the stock.

Ackman is not known for backing down (see MBIA last decade), and he’s remained insistent that he will eventually make money on his HLF short.  He did note that he had restructured his short position into an options position rather than his previous outright short stock trade.

Well, in the past week, 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.

We view those trades as likely related to Bill Ackman’s position.  While it’s not likely that Ackman himself would trade listed options (he likely traded Over-The-Counter or OTC options with a bank dealer to conceal his position size and strike), those trades could be the bank dealer trying to offset some of the Ackman position risk in the listed options market.

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.  Here is the chart of 1 year implied volatility:

1 year implied volatility in HLF, Courtesy of LiveVolPro
1 year implied volatility in HLF, Courtesy of LiveVolPro

Over 60% implied vol for a 1 year option is quite elevated for any stock, but Ackman’s put ownership is one big reason why this is skewed so high.

The Herbalife story has gotten more intriguing in the past week as a result of breaking news on Nu Skin, another multi-level marketing company.  Nu Skin is focused on skin-care and nutritional products.  The Chinese government announced overnight that it is investigating the company after the People’s Daily said the company is operating a “suspected illegal pyramid scheme.”

Nu Skin has a direct sales license in China and the country comprises about 25% of revenues. The Chinese government has historically been more stringent on multi-level marketers.  The news this week has sent the stock down more than 30% in 2 days:

NUS weekly, 50 week moving average in pink, Courtesy of Bloomberg
NUS weekly, 50 week moving average in pink, Courtesy of Bloomberg

The stock’s weakness has hit HLF, which is down almost 10% this week.  China is an important growth market for HLF as well.  Ackman has surely been badgering regulatory agencies around the world about Herbalife’s operations, though so far with little success.  Whether the Nu Skin investigation is just the start, or a one-off with no impact on HLF could determine the viability of those Jan15 50 put options over the next year.