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On October 25th, I noted how intrepid traders had loaded up on November $45 puts ahead of news that Monster Beverage Corporation (NASDAQ:MNST) was implicated in a lawsuit over the death of a girl who drank Monster Energy Drink right before she died. At the time I wrote, MNST had spiked almost 17% after the company defended itself in a press release. I declared the trade in the November $45 puts to be over. While the stock never traded higher and even retested its intraday lows two weeks later, sure enough, come expiration, MNST closed just above $45 at $45.47. Those November $45 puts expired nearly worthless just as MNST happened to remain stuck for almost three weeks just below its 2011 closing price of $46.25.

My assertion at the time was grounded in the belief that trades based on advanced knowledge (or presumed knowledge) of negative news releases are setup to take advantage of the near certain quick trigger, emotional trading that will send market participants selling first and asking questions later. That kind of fear usually has a short shelf life. Tuesday's 13% spike higher is yet one more, I daresay inevitable, phase in the relief of that fear.

MNST stock continued to bounce around the $45 level until Tuesday, November 27th when the stock soared 13% on news that the FDA sent a letter to Senator Dick Durbin (I downloaded the letter from Durbin's press release on the matter) to address his concerns that the FDA provide "additional information on potential interactions and cumulative effects of multiple additives with stimulant properties in 'energy drinks' with caffeine and on health risks associated with consuming high levels of caffeine among young people." The FDA also wanted to take the opportunity to respond to Durbin's request that the agency regulate caffeine levels in energy drinks. The FDA clarified that its investigation focused on the potential hazards of excessive consumption of caffeine by certain types of individuals under the context that there is "a long history of safe use of other caffeine-containing products in the United States."

The letter was full of reminders of the limited scope of the FDA's regulatory authority and the inability to summon enough resources to test all possible combinations of stimulants. The FDA noted that there are no known studies that "call into question the safety of combinations of various ingredients added to energy drinks under intended conditions of use…" The statement/modifier "under intended conditions of use" means that the FDA cannot regulate away the abuse of any substance that under normal consumption is perfectly safe, especially when proper labeling is included on the package defining the intended use. Moreover, the "FDA searched the literature but did not find any information that calls into question the safety of [taurine and guarana] as currently used in beverages."

I can only assume that the traders who bought puts in advance of the original disclosure already knew all this information. They certainly had sufficient time to do the same literature searches that the FDA conducted. The intent of the trade was to take advantage of the initial fear. As the fear recedes, the recent lows could provide a lasting bottom in MNST absent any new revelations or news.

The FDA also sent Durbin a copy of a 2009 report on caffeine consumption in the U.S. that suggests young people get most of their caffeine from coffee, soft drinks, and tea, amounting to 1/3 of the average consumption of caffeine by adults. Energy drinks constitute only a "small portion of the caffeine consumed, even for teens." The FDA also cited the diversity in opinion in the health profession regarding the allowable limits of caffeine consumption for adults and children.

Overall, the extensive content and mild tone of the FDA letter seem to support assertions MNST has already made. Furthermore, it suggests that MNST will eventually be absolved of any product liability although new laws could eventually get passed for alterations in labeling. The options trading in the wake of the FDA's letter is quite telling. Traders scrambled to buy December call options. From the $40 to $60 strikes call volume outnumbered put volume by almost 1.9 times. This 0.54 put/call ratio compares extremely favorably to the 1.2 put/call open interest ratio which ranks at the 88 precentile over the past year.

Calling a likely bottom for MNST is a far cry from calling for a complete recovery in the stock. MNST has been in decline ever since the stock was added to the S&P 500 (NYSEARCA:SPY) in June, 2012. Last month it hit 13-month lows and is greatly under-performing the S&P 500 since then. (Note that Tuesday 13% spike instantly returns MNST to year-to-date out-performance over the S&P 500).

(click to enlarge)

Monster Beverage's trail of tears since all-time highs earlier this year

Source: FreeStockCharts.com

Until last week, the declining 20-day moving average (DMA) has served as a reliable point for fading the stock. Until Tuesday, MNST had only emerged for air above its declining 50DMA once over the past four months. In other words, there is a LOT of overheard resistance for the stock to fight through. While the near-term upside is very uncertain, I continue to like selling puts on MNST on extreme moves to the downside. The next big catalyst for the stock will likely be December options expiration and then earnings in February. In between, I expect a wide trading range shaped by several high-volume bursts of trading based on speculation, rumor, and news headlines.

Be careful out there!

Source: Monster Spike On Mild FDA Letter Setup By Previous Fear-Based Trading