Name That Trade – A Purpose Driven $HLF

by Enis November 3, 2014 11:47 am • Commentary

Herbalife reports earnings today after the close.  We previewed the earnings event on Friday, with the following conclusion:

The earnings event itself is not justifying the elevated vol in the options. Likely the option premium buying is based on rumors of a possible settlement with the FTC. Who knows what’s baked into the stock at this point, but if there is no announcement, the stock is likely flat to down on inline earnings. A settlement could obviously spike the stock much higher.  With vol elevated though, the risk/ reward of selling the move is quite good, especially since HLF traders and investors are well aware of the various moving parts of the story.  We’ll do some more research into event and decide whether it’s worth trying to sell vol into the print.  If we do a trade, we’ll update on Monday well before the close.

The stock is up around 5% this morning, hitting its highest level since late July, right after its last earnings report:

HLF daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg
HLF daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg

With implied volatility elevated, we’ve been looking for a good risk/reward structure that takes advantage of the extremely high level of options premium.  After considering a variety of possibilities, we had settled on the following trade:  

NOTE:  Options markets are very wide in HLF, so any orders should be specific limit orders.

We put a $2.90 limit order out for this structure, but were not filled in the past 20 minutes, so decided to post it as a Name That Trade.  We did NOT execute this order.

Hypothetical Trade:  Buy the HLF Nov7th 62/52/42 Put Butterfly for $2.90

-Buy 1 Nov7th 62 Put for $8.60

-Sell 2 Nov7th 52 Puts at $3.20 each or $6.40 total

-Buy 1 Nov7th 42 Put for $0.70

Break-Even on Nov7th Expiration:

Profits: btwn 44.90 and 59.10 make up to 7.10 with max gain of 7.10 at 52

Losses: btwn 42 & 44.90 lose up to 2.90, btwn 59.10 & 62 lose up to 2.90, below 42 and above 62 lose full 2.90

Rationale:  The break-even range on this trade by Friday’s expiration is $45 to $59.  That is a very wide range for an in-the-money fly, an example of the opportunity offered by the sky-high implied volatility in HLF options.  We have skewed the structure towards the downside as we think the bigger potential move lies in that direction.

Analysts have modeled in about $1.31 billion in revenues for the third quarter, which is the same revenue number as the second quarter.  Given the continued negative publicity for Herbalife, as well as significant dollar strength in the third quarter, that seems like a high bar to us.  Moreover, while executives might talk about the possibility of a settlement with the FTC, any such settlement could pose a serious risk to future revenues and EPS as well, depending on how stringent the terms are.

Finally, on a technical basis, HLF has already rallied more than $15 in the past 6 weeks into this earnings event, and the stock is just below the falling 200 day ma.  This trade structure plays for weakness, but is a winner if HLF is flat or only slightly higher as well.  It expires on Friday, so only risk premium that you are willing to lose, as there is a possibility of the trade expiring worthless on Friday on a big move higher this week.  Overall, we like the risk/reward, would not risk as much premium as a normal trade given that it’s a weekly options trade for earnings.