Shares of Herbalife Ltd. (NYSE:HLF) are up over 40%, so far this year, finally forcing famed short seller Bill Ackman out of his bearish bet. Mr. Ackman’s total loss was rumored to have exceeded $1 billion. The most recent leg up was predicated on the announcement of a name change, stock split and Dutch auction — basically the kitchen sink approach to squeeze the HLF stock shorts into submission.
Now that the bears have gone into hibernation, I think it is a perfect time from a contrarian standpoint to revisit the short thesis on Herbalife stock.
While earnings and revenues appeared solid on the surface, on closer examination all may not be as rosy at it first appears. Volume points, a key metric for HLF stock, actually decreased 3.6% from a year ago. Reported net sales for the full year of 2017 also showed weakness, dropping 1.1% year-over-year.
Earnings have stagnated over the last several years in HLF, while the stock has risen to a new all-time highs, meaning Herbalife stock is now trading at by far the richest price-to-earnings multiple over the past 10 years. Certainly, a multiple contraction (and therefore lower prices) would not be unwarranted.
HLF is also getting extremely overbought on a technical perspective: its 14 day RSI recently breached the 80 level for only the fourth time in the past year. Each previous time Herbalife stock was this overbought signaled a significant short-term top in the stock.
The price action from yesterday was also telling, with HLF attempting to break out to fresh new highs only to fail and close lower on the day. This type of reversal pattern, especially after such a big-time rally, is usually a reliable indication that the buyers may finally be exhausted.
Implied volatility in HLF options is at the 44th percentile, which is ideally suited for spread strategies. So to position for a pullback in Herbalife stock, a put diagonal spread makes intuitive sense.
Trade Idea: HLF Stock
Buy the HLF Apr $95 puts and sell the HLF Mar $92.50 for a $3.10 net debit. Maximum risk on the trade is $310-per-spread. Ideally, HLF closes near $92.50 at March expiration.
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 email@example.com.