Let’s go ahead and get this out of the way: Herbalife (HLF) is a mess right now. The company is not only dealing with an investigation into its business practices by the U.S. Federal Trade Commission and the FBI, but it also is facing some potentially serious currency exchange issues between the Venezuelan bolivar and the U.S. dollar.
Adding to this baggage is the company’s third-quarter earnings report, slated for release after the close on Monday, Nov. 3.
On the FTC/FBI front, activist investor Bill Ackman of Pershing Square Capital Management has accused Herbalife of operating as a pyramid scheme; a claim that the company fervently denies. Meanwhile, Venezuelan currency exchange rates changed significantly in 2014, leading HLF to make the following statement in its second-quarter 10-Q filing:
“If foreign currency restrictions do not improve, we may have to use alternative legal exchange mechanisms or less favorable official exchange mechanisms, such as SICAD 2, which are significantly less favorable than the official SICAD 1 rate which could cause the Company to incur significant foreign exchange losses.”
How significant? Estimates put the potential impact at a $90 million one-time loss if Herbalife is forced to switch from the SICAD 1 rate to SICAD 2. Currently, analysts are projecting third-quarter earnings of $1.52 per share, but an exchange-rate hit during the quarter could lower earnings to roughly 52 cents per share. Ouch!
Judging from the wealth of pessimistic sentiment on Wall Street, though, much of this news may already be factored into the shares. For one, short interest totals 28.5 million shares of Herbalife stock. This equates to a whopping 47.46% of HLF’s total float, or shares available for public trading.
What’s more, these short sellers don’t appear to be nervous in the least. Typically, short sellers buy call options to hedge their positions against potential losses. With a November put/call open interest ratio of 2.24 for Herbalife stock, it’s clear that there is miniscule hedging going on, if at all. This ratio grows even more bearish when we zoom in on the weekly November series, arriving at 3.60, with put open interest more than tripling call open interest for options set to expire at the end of next week.
Click to Enlarge Overall, weekly November implieds are pricing in a potentially sizeable post earnings move of 16.5%. This places the upper bound at $58.25, while the lower bound lies at $41.75. An upward move launches HLF above all major technical hurdles save the 60 level, while a negative reaction would place Herbalife stock near its correction lows in the $40 area.
Options Trade on HLF Stock
Given the high levels of volatility currently priced into HLF stock, I would recommend waiting until after Herbalife’s quarterly report to enter an options position on the shares. That is, unless you have a real taste for risk.
In that case, siding with the bears over the short term has the potential to be profitable.
Those willing to take the plunge might consider a Nov $45/$50 bear put spread. At the close of trading on Wednesday, this spread was offered at $1.84, or $184 per pair of contracts. Breakeven lies at $48.16, while a maximum profit of $3.16, or $316 per pair of contracts, is possible if HLF closes at or below $45 when November options expire.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.
