Back in a January post we detailed the activity in the Jan15 50 puts in HLF when the stock was in the low $70s after a quick decline from the recent highs int he lows $80s:
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.
Well, around noon today, the trader rolled the Jan15 50 puts out to the Jan16 50 puts, selling 28,000 of the Jan15 50 puts at $8.05, and buying 32,200 of the Jan16 50 puts for $15.55. It looks like Bill Ackman is on the move again, paying an additional $7.50 in premium to roll the short HLF view out to Jan16.
What’s interesting about this trade is that the Jan15 50 puts were bought back in January 2014 at $7.10 and $7.25 when HLF was still in the 70’s. Today, HLF is around $50, and the put has only appreciated around $1.00 as a result of time decay. Moreover, the cost to roll the put position out to Jan16 means an additional $7.50 in premium, and since there was not much of a gain on the Jan15 50 put, the total premium at risk for the trader is nearly $15 for the Jan16 50 put. In other words, the break-even for the entire trade from initiation in January 2014 is currently around $35 for the Jan16 50 puts that were opened today.
Add to that the fact that the trade position is now bigger today than it was on a premium basis 6 months ago, and you could argue that Ackman is actually increasing the size of his bet. While he has given himself one extra year, he also has doubled the total potential loss if HLF rallies or remains above $50 by January 2016 expiration. Some who would argue that that’s a sign that regulators like the FTC might be taking longer than Ackman had hoped in investigating Herbalife. Whatever the reasoning, it’s quite surprising to see a put trade that only offers 2.33 to 1 upside if the company goes all the way to 0 ($35 potential gain vs. $15 potential loss). That is an indication that Bill Ackman is betting on the stock to go to 0 due to regulatory action. He is not in this trade for a decline to $25.
Timing is a crucial issue for any options trade, but particularly so for a situation that is so public. Herbalife management is also watching Bill Ackman’s trading very closely, and I’m sure they’ll take notice of today’s roll as well. In fact, part of the reason they probably were so aggressive in buying stock earlier this year was to delay any decline in HLF stock to put more pressure on Ackman as his puts decayed. Matt Levine laid out the rapid pace of that buying in a late April post:
Those are irresistibly big numbers, and I did not resist them. Here are Herbalife’s share repurchases, as a percentage of daily volume:
Those are kind of wild numbers! And, actually, the first-quarter numbers are a bit exaggerated, since Herbalife did most of its buying in one big swoop, from hedge funds who were naturally set up to sell stock to hedge the convertible that it issued. If you ignore that one day of buying, basically Herbalife averaged less than one percent of daily volume for the previous 15 months — and then almost 10 percent of volume in April.
Or another comparison: Net income over the past 15 months totals about $650 million; cash flow from operations was a little under $1 billion. Throw in the $297.4 million that Herbalife spent on share repurchase last year, and you get over $1.3 billion of share repurchases and related transactions in the last 16 months, well ahead of operating cash flow and more than double net income. Herbalife is funneling money to shareholders faster than it can make it.
We actually put on a bearish trade in Herbalife after the late April earnings announcement, with the thought that the company had used up most of its buyback ammunition in the first 4 months of the year. We took that trade off for a profit at the start of August.
Now, Ackman’s latest move puts a bit more pressure on HLF, as he might be sticking around for another full year to see his thesis through. Given that HLF has much less buyback ammunition, the real fight now will be on the regulatory front. Herbalife management should see quite clearly that Bill Ackman is playing for a closure of the company, not just a large stock decline. With that in mind, Herbalife executives are likely to regroup and strategize about how best to address the many issues that Ackman has brought up and regulators are likely to probe. The stakes have been raised. This has become a fight for survival.