Shares of Weight Watchers (WTW) rose 105% Monday following news that Oprah Winfrey took a 10% stake in Weight Watchers stock, agreeing to invest $43 million for 6.4 million shares at $6.79 per share. In addition, Ms. Winfrey received options for an additional 5% stake in the company.
WTW added on an additional 31.10% on Tuesday, closing at $18.24, for a two-day total gain of 169%.
For those keeping score, this puts Oprah’s two-day stock appreciation at roughly $73.34 million, not including the potential of an additional $36.67 million on the options. Together, it totals out to a $110 million windfall, at least on paper. Talk about the Oprah Effect!
In addition to Oprah’s big windfall, the market cap of Weight Watchers stock has been fortunate enough to have a similar windfall, moving up past the $1 billion level. Short covering certainly helped fuel the enormous rally, since WTW had a short interest of 15.7 million shares, or nearly 28% of the float, and was at 15 days to cover as of the last report.
The past few days’ enormous volume on the open, with subsequent tapering off throughout the day, is indicative of buy-ins of the shorts by their firms, as seen in the chart. I would certainly expect the short covering rally to be tempered going forward.
Technically, Weight Watchers stock did fill in the gap following the Feb. 16 disastrous earnings report at the $17.50 level. A significant break back below this level could lead to a swift technical selloff.
While many investors, especially momentum investors, tend to get myopic following such seismic price moves, it’s important to remember that Ms. Winfrey is long the stock from Friday’s close of $6.79. Anyone going long WTW based on today’s close of $18.24 means they would be paying 169% more than Oprah did just two days ago for her Weight Watchers stock.
The options granted to Ms. Winfrey are also very dilutive, meaning her potential 5% additional stake via options would be detrimental to the shares of Weight Watchers. The short squeeze is most assuredly diminished at these levels, so impetus for more short-covering gains is minimal.
From a trader’s perspective, I think both probabilities and magnitude of move favor a counter-trend bearish trade. I feel the probability of a pullback is greater than a continuation of the rally at these levels, and I also think the magnitude of the pullback could be much greater than that of an up move.
Shorting WTW stock is still a dangerous game, so I think structuring a bearish option trade with defined risk makes sense. Since shares of Weight Watchers are hard to borrow, normal put-call parity no longer applies, meaning outright puts are expensive. It is prudent, then, to include some option selling in the overall trade structure to mitigate the effect.
For traders with a bearish viewpoint looking to put on a defined risk trade in WTW, I think a ratio calendar trade makes intuitive sense.
The WTW Stock Trade
Buy 5 WTW Jan $16 puts and sell 4 WTW Nov $16 puts.
As of the latest check, the Jan $16 puts were offered at $2.85 and the Nov $16 puts were bid at $1.75. The implied volatility on the Jan puts is 118%, while the Nov puts carry a steeper implied volatility of 136%. The max loss on the trade is the total net debit paid of $725. With the extra long put, the trade is set up to continue to profit on any move past the $16 strike price by November expiration, with max gain around the $14 level.
As of publication, Tim Biggam had no positions in the aforementioned securities. Anyone interested in learning more about put-call parity and trade structuring discussed in this article, or anything options-related, can e-mail him at tbiggam@deltaderivatives.com.
