Trade Update – $HLF: Taking Off Put Butterfly for a Profit

by Enis August 4, 2014 1:56 pm • Commentary

HLF got within sight of its 52 week low of $49.35 this am, as the selling has been relentless ever since Herbalife’s disappointing earnings report in late July.  While Ackman’s presentation a couple of weeks ago hardly had the desired effect on that particular day, his persistent campaign against the company might be hurting HLF’s actual business, as opposed to just investor and regulator perceptions. Interestedly, some of the selling since the big presentation was probably enabled by the short squeeze that it caused, as many of the shorts in the stock got taken out and therefore are no longer acting as buyers on down days.

In any case, our August put fly position is now nearly a double, and the intrinsic value of the position nearly matches its actual value in the market at the moment.  Given HLF’s massive volatility in the past month, we’ll take our nice gain here near the important $50 technical support area:

Action: HLF ($50.75)  Sell to close the August 55/40/25 put fly at 4.50 for a 2.00 profit

– Sell to close 1 August 55 puts at 5.00

– Buy to close 2 August 40 puts at .25 (.50 total)

– Sell to close 1 August 25 put at .02 (this is optional if you don’t want the commissions of closing)

 

 

 

New Trade – HLF: The Game of Herbalife

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Earlier this morning I laid out my thoughts on HLF’s results, guidance and capital return.  For those that missed it, my succinct view, is it’s NO BUENO. Yesterday on the close I bought a weekly put fly (here) expiring Friday as a low conviction play that the regulatory issues would overshadow better than expected fundamental info.  Well, the company’s announcement to suspend the dividend and buyback shares this week, is propping up the stock this morning, but only marginally.  When the company is done buying back this round, and I am not sure how much more they can lever up, the next negative headline could be a glancing blow to longs.

I am now going to put on a new trade to express this bearish view, but leave my weekly trade on as well:

TRADE: HLF ($60) Bought the August 55/40/25 put fly for 2.50

-Bought 1 August 55 put for 6.30

-Sold 2 August 40 puts at 2.15 each or 4.30 total

-Bought 1 August 25 put for .50

Break-Even on August expiration:

Profits: gains of up to 12.50 btwn 52.60 and 40, max gain of 12.50 at 40

Losses: up to 2.50 btwn 25 and 27.50 and 52.50 and 55, with max loss of 2.50 above 55 and below 25

RATIONALE:  HLF implied volatility is still relatively high (likely since Mr. Ackman owns so many puts), so we wanted to use a put fly rather than a put spread to cheapen the premium on a bearish view.  We went out to August to give us more time.  Finally, we chose the strikes because HLF’s main support level is $40, which is near where the stock was when Mr. Ackman first announced his short position more than a year ago.

 

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Original Post April 29th, 2014:  MorningWord 4/29/14-HLF: I Didn’t Choose the Herbalife, It Chose Me

I have no axe to grind with Herbalife (HLF) (have a very small short biased options position-here), but as a market participant who generally likes to follow/invest/trade public companies that are focused on creating great products, building a strong consumer and/or commercial brand, growing market share, competing aggressively and have transparent financial dealings/reporting, I can’t say that HLF checks too many of those boxes.

Last night HLF issued their Q1 results that seemed about as gimmicky as it gets. What do I mean by that? Well simple, issue an earnings report for the quarter just ended that beats Wall Street estimates handily, guide the current quarter down and then raise full year eps.  The obvious push out in my opinion.  Here is the summary:

Q1 estimate was for 1.30 in eps, reported 1.50, mazel tov!

Q2 estimate was for 1.56 in eps, guided to 1.51 to 1.55, mild downgrade.

2014 estimate was for $6.04 in eps, guided to 6.10 to 6.30, vs prior guidance of 5.85 to 6.05, raising the mid point 3.5% above consensus, which would represent about 12% year over year growth.

What I also find interesting is that sales growth for HLF is decelerating at a fairly rapid pace for a company that attracts so much attention. In each of the last two years, HLF has grown sales 18% a year, while analysts only expect sales to grow about 8% for the next two years.

For those of you who are not following at home, this stock is a battleground between 2 hedge fund titans, Bill Ackman of Pershing Square who is basically most of the short interest between short stock and long puts (about 33% of the float), with Carl Icahn on the other side who is the largest holder with 17 million shares or about 17% of the stock.  I don’t pretend to have any insight into either investor’s thinking, but despite Mr. Icahn’s tweet last night expressing his agreement with HLF’s actions to suspend their dividend to buy back more stock, I would be more emboldened if I were on the short side.


Last night’s decision to suspend their $1.20 a share annual dividend and use the proceed to buy back stock 2 months after the company issued a convertible bond where they raised $1.15 billion and used the proceeds to buy back shares mostly at much higher levels appears a bit desperate.  Which brings me back to last quarter’s Q1 20 cent beat, which also equates to the amount that the company raised full year guidance by.  The company is beating earnings by retiring shares and pulling out any and all stops to do so to keep the stock buoyed as regulators and law makers are bearing down on their selling practices.  So to me it all seems a bit of gimmicky, like a shell game, the exact sort of shell game that Mr. Icahn in years past might have lambasted a management and a board for implementing.

Again, Mr. Icahn has put a considerable amount of capital behind his belief that HLF’s sales practices are on the up and up, that they sell products that actually work, that the stock is considerably undervalued and that most of all Mr. Ackman is dead wrong and will be carried out on his thesis that the company is a pyramid scheme and that it will be shut down by regulators.  He basically outlined his strategy for the HLF investment on his CNBC battle with Bill Ackman last year – he simply wants to squeeze Mr. Ackman until Mr. Ackman is finally forced to cover his short.  And my guess is that if and when that happens, Mr. Icahn will be giddily selling his shares to Mr. Ackman at higher prices.

However, the news flow over the past 6 months has gotten more negative as the regulatory scrutiny on the company has increased.  So Mr. Icahn’s game plan has not exactly worked as planned, though he also knows that Pershing Square owns Jan15 50 puts (the single largest strike of open interest at 67,000 contracts we described here on Jan 16th) that Mr. Icahn would love to expire worthless and thus deplete Mr. Ackman’s coffers.  HLF management knows that as well, so the company might know that it’s on thin ice, but if it can keep the stock propped up over the next 9 months, maybe Bill Ackman will finally have to simply take his loss on his options and reconsider his short stock position.

Nonetheless, Herbalife has used an awful lot of ammo in the past few months, and the stock is still lower in that period.  That might be all the evidence we need that HLF is headed lower, even as management seems more focused on squeezing a short as opposed to mounting a solid defense to increased regulatory scrutiny.  The company is becoming increasingly levered in an effort to achieve this final point, and frankly I am surprised that there has not been a bid to take the company private by an investor group given what appears to be the company’s apparent confidence about the viability of their business model.

One last point, my trade referred to in first paragraph was a throw away trade, but the trade that I may look to do is a ratio put spread that I detailed back on March 3rd: Name That Trade: HLF – If I Had A Billion Dollars, Stay Tuned.