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Dr. Duru, One-Twenty Two (112 clicks)
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The negative news cycle has begun again on Monster Beverage Corporation (MNST), and it is creating fresh trading opportunities.

On January 10th, the Drug Abuse Warning Network (DAWN), "a public health surveillance system that monitors drug-related morbidity and mortality" run by the Substance Abuse and Mental Health services Administration (SAMHSA) through the Federal Department of Health and Human Services, produced a report titled "The DAWN Report: Update on Emergency Department Visits Involving Energy Drinks: A Continuing Public Health Concern." This report updated a similar report from November 22, 2011 and included several citations of related research. They key finding is expressed simply in the chart below.

Reason for Energy Drink-Related Emergency Department (ED) Visits, by Year: 2005 to 2011

After last peaking in 2008, there was a large increase in emergency room visits of patients who reported consuming energy drinks as at least part of the reason for their visit. The bulk of this growth comes from adverse reactions. DAWN explains that adverse reactions are counted when the hospital chart indicates an adverse reaction or side effect from the substance or an adverse interaction with another drug or with alcohol. Misuse or abuse includes cases with illegal drugs or cases with abused legal drugs (including illegal consumption of alcohol). Fifty-eight (58) percent of all 20,783 energy drink-related emergency department visits involved only energy drinks.

On the day of the release, MNST dropped 3.1% on average volume. All these losses were reversed the next day and the stock proceeded to drift along its 50-day moving average (DMA). This relief was disturbed on January 17th when Representative Edward J. Markey and Senators Richard J. Durbin and Richard Blumenthal published an ominous letter sent to the President of Living Essentials, maker of 5-Hour Energy. This letter asks Living Essentials about how it classifies, markets, and advertises its energy product. It also asks about caffeine content. The Congressmen requested a response by February 1, 2013.

More importantly, the letter reveals that the Food and Drug Administration (FDA) "…is launching an investigation to strengthen its understanding of energy drinks and health risks posed by these products for vulnerable groups including young people and those with pre-existing cardiac conditions." MNST dropped as low as $49.84 that day but bounced back by a point to close the day for a small loss of 1.4%. So once again, it seemed as if motivated sellers were mostly shaken out of the stock already, and that the market had learned its lesson from the last product scare in October: mainly, that there are nuances beyond the headlines that may lead to contrary conclusions. Moreover, the FDA's response in late November to a Congressional inquiry suggested that MNST would ultimately be absolved of culpability in a wrongful death lawsuit.

However, on January 18th, vague rumors about a short-seller active in MNST shares (according to briefing.com) renewed headline fears and uncorked more selling pressure. MNST dropped as much as 8.1% before a MNST press release responding to the DAWN report sent the stock bouncing back for a closing loss of 4.1%.

Initially, it seems surprising that MNST waited 8 days to respond to the DAWN report. However, the 2011 DAWN report generated no selling pressure on the stock. As far as I can tell, MNST never issued a response to the 2011 report. What likely motivated a response this time around was the news of an actual FDA investigation. The company's rebuttal makes sense:

  • No causal links or specific diagnoses are provided in the DAWN report.
  • The existence of multiple substances in some of the patients confounds the results.
  • No comparison is provided for emergency visits caused by other highly caffeinated beverages.

Strangely enough, DAWN's comparison of the caffeine in energy drinks versus coffee uses no measurement of the volume of a typical energy drink and uses an extremely small serving size for coffee:

The total amount of caffeine in a can or bottle of an energy drink varies from about 80 to more than 500 milligrams (MG), compared with about 100 mg in a 5-ounce cup of coffee or 50 mg in a 12-ounce cola.

Outlets like Starbucks (SBUX) regularly serve 8 to 16 ounces of coffee in a single serving. MNST specifically clarifies that: "Monster energy products generally contain approximately 10 mg of caffeine per ounce from all sources." This means that a 16 ounce can of a Monster energy drink contains the same amount of caffeine as an 8-ounce serving of coffee, a very typical serving size.

In other words, the strongest conclusion one can make from the DAWN report is that perhaps there is an alarming change in consumption behavior of caffeinated drinks and not that energy drinks themselves have suddenly become more dangerous. If any subsequent rulings from the FDA get applied to MNST, they will need to be applied to coffee as well, not very likely.

When I first saw MNST's stock plunging, my reflexes sent me to MNST options for trading clues before selling puts into the heightened anxiety. At the time, I tweeted "On $MNST plunge, put volume soaring vs open interest: Jan 47.50 (!), Feb 45." With volume soaring on near-the-money puts expiring the same day (January 18th was expiration day for January options), I figured there was a high likelihood of a lot more selling pressure. So I placed my limit order to sell (short) the Feb 45 puts at $2.20 while they were selling for roughly half that amount. It then occurred to me that the Jan $47.50 puts would get a lot more valuable if my limit order triggered. So I next joined the bandwagon and bought the Jan $47.50 puts while they were selling for $0.45. Sure enough, MNST started dropping fast, and I was able to exit with a 3x gain. At the same time, I moved up my sell order of the Feb 45s to $2.80. Ironically, the high of the day on those puts was $2.30, and it closed at $1.20.

This opportunity had a very small window. The stock bottomed 2.5 hours into the trading day. While it was good to take advantage of the downside momentum, the primary lesson was still in noticing when the selling gets overdone. In this case, the bottom occurred well after MNST punched through what is known as the lower-Bollinger Band (BB). The BB describes, roughly, the expected or "normal" volatility in a stock over a period of days. In the chart below, the area of the BB is shaded grey; the borders depict the 20-day moving average for volatility ranging over two standard deviations. So when a stock trades through the upper or lower limits, a trader can consider the stock short-term over-extended on the buy or sell side respectively. Finally, note that ever since MNST joined the S&P 500 (SPY) in June, MNST has experienced several bouts of extreme selling that have in turn quickly led to relief rallies of varying durations. Each time, headlines have driven quick trigger selling, culminating in the wash-out selling in October (recall THAT episode featured some precociously active put trading ahead of the related news release).

(click to enlarge)

Monster Beverage has experienced several sharp bouts of selling since June

Source: FreeStockCharts.com

I prefer selling puts into this kind of extreme selling (instead of buying calls) because I can benefit from both the increase in the stock price and the decline in volatility which erases some portion of the options premium. The stop point is very clear, and I can benefit even if the exhaustion of selling only leads to the stock bouncing along its low point. MNST's behavior has been a lot more consistent than one could hope to expect, thus my extra caution on Friday selling the puts combined with my willingness to follow the momentum for a short spell this time around.

Some ambivalence in MNST showed up by Friday's close. By day's end, traders loaded up on the February $50 calls with trading volume of 2,929 contracts versus open volume of 2,182. The overall volume put/call ratio was 1.6 versus open interest put/call ratio of 1.2. Trading was lighter in the March options and almost non-existent for the June options. This configuration suggests that traders are speculating on the short-term dynamics of fear rather than a firm belief in the lasting impact on MNST's business (or stock) from all these headlines. According to Schaeffer's Investment Research, the open interest put/call ratio of 1.38 is a 52-week high. At the same time, short interest is also close to a 52-week high at 4.34M shares although it is only 2.8% of the float. In other words, while the negativity on MNST is high relative to previous trading, it is not particularly high on an absolute basis. Plenty of ambivalence remains, and it will only likely get resolved after several more bouts of alarming headlines and extreme levels of selling.

Be careful out there!

Source: Renewed Headline Fears Generate Fresh Trading Opportunities In Monster Beverage