Investing is difficult. Regardless of the number of big headed investors saying otherwise, the fact that the majority of mutual funds underperform their appropriate benchmark is proof that investing is not easy. That said, every so often you come across a trade that is a can't miss, one that you just know in the depths of your soul will make you money. If you act quickly, Herbalife (NYSE:HLF) may give you that very opportunity.
An opportunity like this requires 4 ingredients that factor into the success of the trade: volatility, impending news, time and pricing. If you are missing one, you might swing by with a small gain but ideally all four are desired. Herbalife, to our good fortune, has all four and in a big way.
Volatility - I don't think I need to address this because I think the Carl Icahn v. Bill Ackman battle has garnered plenty of attention, but I may as well rehash for those unfamiliar. Bill Ackman, founder of the Pershing Square hedgefund with several billions of dollars under management is the Herbalife Perma-Bear, with a short position claimed to be over 20 million shares. His beliefs are that there may be accounting discrepancies, but even worse, he has been the recent leader in a vocal opposition of those calling Herbalife's sales methods a pyramid scheme.
Carl Icahn on the other hand has acquired 17 million shares (using his own funds and NOT a hedgefund) and has been vocal regarding the undervaluation of the company. Joining Icahn in his corner are George Soros, William Stiritz and Dan Loeb. I don't think any further explanation for how much money is in the game between these 5 major players. With 30% of shares held short as of the last semi-monthly check and well over 30% of the shares held by money grubbing, revenge seeking hedgefunds, the volatility of the "common" stock has been significantly increased.
*Note: While I have my opinions on the Herbalife debate, the great thing is they need not matter! Personally I think Herbalife has a strong business model that isn't violating any regulations, but if you disagree with me that's no big deal, because we're taking both sides of this trade! Just a little teaser there, you'll find out more a little further on down!
Impending News - Pricewaterhouse Coopers will be auditing the companies past financial records and in the coming months will be releasing the results of such an audit which will help sway the needle in one direction or another. Furthermore, Bill Ackman has been vocal in trying to get the FTC to look into HLF for its business practices. If the FTC decides to come out with a statement regarding their "looking into" of HLF's business practices, regardless of whether the statement is positive or negative, there will be significant market action. Further impending news could be brought upon by any actions the major investors take. This includes even a tender offer by Carl Icahn, an idea that many see as possible, maybe even likely.
Time and Price - These final two variables don't actually deal with the company itself but instead with the underlying option contracts currently existing on the stock. At last check, an investor (large or small) could purchase February 2014 expiry call and put options which have approximately 157 days on their life at very reasonable prices. 70 strike call options for this expiry last traded at $11.50/contract while put options at the same strike trade for $12.25/contract.
Given the extreme impending volatility, $23.75/straddle seems like a relatively fair price to pay. If there is regulatory action on the company, assets could be frozen and the stock's price could plummet rather quickly following the news. Using the 70 strike straddle, the breakeven point would be $46.25. Given that when the stock traded in the 20's when Mr. Ackman announced his short position, I see a breach of the $46 level very plausible with the right negative news.
On the flip side, the upper breakeven point is 93.75/straddle. It's much more difficult to place a realistic potential profit on the high side because it is unlimited, the benefit of being long vs. being short. That being said, several analysts have seriously mentioned $130 as being a viable price target, which would imply $36.25 of potential profit from the straddle. With 30% of shares being held short, which amounts to approximately 8.5 days worth of volume, a short squeeze pushing the stock above $94 is quite likely.
So after reading the likes of Mr. Matt Stewart's articles and the lengthy debate that is derived from them, how about we all put our differences aside and no matter who you are or what you believe, put yourself in a position to profit nicely from the inevitable future volatility? Remember, investing is difficult, I think we could all use an easy road to travel once in a while!
Disclosure: I am long HLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long both Call options and Put options on HLF.