Herbalife Ltd. (NYSE:HLF) jumped nearly 10% Friday on news of a $200 million FTC settlement. While the settlement removes some of the overhang, and caused further pain for shorts like Bill Ackman and his Pershing Square hedge fund, the stock reaction points to a major top in the stock.
I look for HLF stock to struggle to head higher from current levels.
While the FTC decision was initially viewed as a major victory for Herbalife, a further analysis shows that the decision will also force HLF to change the marketing and recruitment process. More importantly, Herbalife will be required to change the way it measures sales, so look for a definite drop in reported revenues going forward.
HLF stock also failed once again at the critical $66 resistance level, as seen in the chart. Shares previously were unable to pierce the $66 area numerous times in the past.
HLF Stock Charts
HLF stock also had a major reversal day on Friday, with the stock racing all the way up to $72.22 before pulling back sharply to close at $65.25. This type of price action is many times indicative of a blow off top, with shorts being squeezed and forced to cover the position.
The fact the stock failed to close above the critical $66 resistance level further enforces the notion off a blow off top in Herbalife. With the shorts now likely forced out, one of the big drivers for potential further price appreciation in HLF stock has been eliminated.
Herbalife has famously been a battleground between hedge fund giants Carl Icahn (HLF bull) and Bill Ackman (HLF bear). Mr. Ackman has referred to HLF as a pyramid scheme on numerous instances in the past and is still looking for the pyramid to collapse. Mr. Icahn stated that the FTC ruled that Herbalife was not a pyramid scheme. In truth, FTC Chairwoman Edith Ramirez stated that “They [Herbalife] were not determined not to be a pyramid. That would be inaccurate.”
So much for clarity.
While the FTC ruling may continue to cloud the issue, the reaction of HLF stock following the news is certainly clear — HLF stock has seen a top.
While implied volatility (IV) has dropped somewhat following the FTC decision, it is still trading at the 45% percentile.
To structure a bearish trade with defined risk, I am selling an out-of-the money call spread.
HLF Trade Idea
Buy July 29 $73 calls and sell the July 29 $70 calls for a 35-cent net credit or better.
The maximum gain on the trade is $35 per spread with the maximum risk of $265 per spread. Return on risk is 13.20%.
Earnings are August 3, so the position will expire before then to avoid earnings risk. I would look to cover the trade on a meaningful move past the $72.22 level, while letting the spread expire worthless and keep the $35 initial credit if HLF stock remains well-behaved.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
