Sunday, January 18, 2015

Herbalife after the January option expiry: Part 1

I have deliberately refrained from writing about Herbalife until the 17 January 2015 option expiry.

We know from public disclosures that Pershing Square (PSQ) had a huge put option position on Herbalife.

There were also a vast number of put options that expired on 17 January.

Here are the outstanding in-the-money put contracts as at market close Friday.

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They add up to 325 thousand contracts outstanding representing 32.5 million shares.

These options expired on Saturday morning and I presume that the stock has been delivered.

The delivery of these options may have a profound effect on the Herbalife share register. These effects will be part of this series. For reference there are less than 82 million basic shares outstanding and about 91 million diluted shares. However basic shares are the right comparable because delivery has to be effected through basic shares outstanding.

It was generally assumed that these options belonged to PSQ.

Bill Ackman however has issued a denial. To quote:
To set the record straight, 97% of the Herbalife put options owned by Pershing Square have been extended and have expiration dates up until 2016.  The January put options held by Pershing Square have a strike price of $US65 share. Pershing Square may choose to extend, sell or exercise the January put options depending upon market conditions and other factors.
Those in the know have understood that the options expiring on 17 January were not PSQ's options.

PSQ's option position in Herbalife is an off-market position.

I know the contract terms as do many others.

Some of the strikes are very unusual.

They include 44,362 call contracts [which I presume hedge a short position] expiring on 17 April with the very unusual strike price of $69.99. [The contracts represent 100 shares.]

They also include puts expiring 15 May, 11,550 contracts with a $44.50 strike and a further 19,500 contracts with a the unusual $49.99 strike.

There are a further 25 thousand contracts for calls with another $69.99 strike.

I could go on... and on. Ackman's position is well known amongst connected and sophisticated longs.

Moreover like many things that Bill Ackman says he is being cute-with-the-truth. Bill said his "puts" largely didn't expire on 17 January. He however owned a large number of calls that expired - and these calls hedge the oversized short position. For example PSQ carried 4,375 call contracts that expired this weekend with a strike price of $89.90. Presumably these hedged 437,500 short positions.

I wouldn't bother disclosing that I knew details of PSQs unlisted positions except that it is useful in future posts.


Post script: If you (like me) believe that Herbalife is a legitimate business and (like me) you believed that the end game was a private equity bid - then I have a puzzle for you.

How could you - knowing the detail of Bill Ackman's position - make a simply humungous amount of money at least partly at the expense of Pershing Square and their clients? Because I assure you some people want to play rope-a-dope with Mr Ackman. [If you think that Carl Icahn has really suddenly become Bill Ackman's bosom buddy then you don't know Carl...]

Secondly: I suspect that this post will cause Pershing Square's office to be quiet and unusually tense on Monday.

Can you say witch-hunt?

Sure, I knew you could.


Anonymous said...

Buy calls or stock, and then arrange a bid for the company at a price below the strike price of PSQ's calls?

Anonymous said...

Contact the private party offer to take the other side of PSQs position, take delivery of the stock on the puts, announce a bid monday just under PSQs the point of maximum pain on their long call position (just below largest ownership at strike. Could also take the opposing positon on those calls and collect the premium knowing the will expire worthless after your bid)

Anonymous said...

Correct me if my logic is wrong here.

1) Most, if not all, puts expiring Jan 17 were exercised since many of them are substantially in the money.

2) The put owners don't own the stock. A good assumption since the puts represent 32.5 million shares, or 40% of outstanding (or 43% of float). Top institutional holders own 67% of outstanding (as of Sept 30) of which Carl Icahn owns 18.5% (Yahoo Finance).

3) The put owners expect to purchase the stock when the market opens after the weekend. This means there is currently (between exercise and when the market opens) a huge naked short position to the tune of about 25 to 30 million shares.

4) The market-makers of exchange-traded puts were probably short a large amount (25 to 30 million?) of the stock as a result of delta-hedging as the stock went down. But, the put owners will deliver the stock to them. So, they are not on the hook for much.

5) Then, there's Ackman. It looks like he has a 10+ million short position hedged by calls.

6) If a private equity bid were to be announced before the market opens, it could result in a mad scramble for the shares.

Anonymous said...

Stock market is closed on Monday (MLK), so they will worry on Tuesday.

With the sort of year they had in 2014, they will not be worried by such a post. I hope you're correct, but you won't scare them with the post.

Anonymous said...

Please clarify:
1) Why do you say that "the put owners expect to purchase the stock when the market opens after the weekend"? Would't that be the case with call options that are exercised?
2) How can you exercise puts if you do not have shares?

Josh H said...

Some of the option trades were spreads and offset each other. For example, a trader might be long 40 puts and short the 35 puts. After expiration their position nets to 0.

For me, I was long the 35 puts short the 30 puts. Since the 30 puts were out of the money, I bought HLF shares with 5 minutes before the market closed. My position is 0.

Anonymous said...

You're assuming those shares weren't sold by Stiritz, Icahn, Fiedilty or Cap. I think you're wrong.

J said...

I wish I had the right to sell 32 million HLF shares at an average price of $53.89 right now! :-o

Clayton said...

That'd be a pleasant suprise. I sold a couple of those 35's a few weeks back, the shares showed up in my account today. I thought something was up the last couple of weeks with ackman agressively talking hlf down in the media. I was wondering how he was gonna exit his position if he had to deliver on his itm contracts without affecting the share price substantially..

Anonymous said...

This is the best to-be-continued moment since the 1995 Simpsons episode, "Who Shot Mr. Burns?"

Anonymous said...

A hedge fund manager who doesn't know the market is closed today...

You don't see that everyday!

John Hempton said...

To be fair - I barely trade. Hence not knowing the market is open is - well - ordinary for me. Happens regularly.

Anonymous said...

How do you justify a PE bid when this company has just put about 2B of debt on it's B/S? what sane PE firm would step in front of this coming train and add more debt?...trying to save your position?

Anonymous said...


Your analysis of Herbalife has been 100% incorrect. Why on earth should anyone listen to your absurd predictions now?

A Herbalife buyout requires an investor to assume 100% of the liability for the converts that now trade at 69 cents plus pay a premium for the equity?

This is crazy talk.

Carl Icahn isn't looking to increase his exposure to HLF. He wants out. What would the interest rate be on an LBO loan for HLF here? They have no assets/collateral, etc?

You are clearly delusional John. Good luck with that.

Tom said...

....and while all this is going on... the DOJ announces indictment of Management, top Recruiters and the Company...? They could use SAC Capital as the template... "30 criminal enterprise, a breeding institutional indifference to criminal activity...on a scale without known precedent in the industry. And today it stops." Nobody thought SAC was going to be stopped either; the largest and most successful...until it wasn't Oh well. (I think the troubling part of that one is... the Crime Boss isn't in jail.) Keep dreaming that PE is going to bail this out, or Uncle Carl is going to double down on his obvious mistake.

Anonymous said...

This is the one of the best examples of cognitive dissonance that I have ever witnessed. You are going to have a hard time explaining this one to your investors when the FTC shuts this down. How are you going to be able to explain that you didn't see this coming? Only a man blinded by hatred has the inability to see the flaws that are clearly present every where in his analysis. It's either sheer incompetence or sheer madness. I don't know you well enough to know which it is. Good luck mate.

Anonymous said...

This post betrays a profound and disturbing lack of understanding of the mechanics of the option settlement process. You may want to consider shelving "Part II". On second thought, what was that old Napoleon quote? Carry on...

Anonymous said...

I am enjoying this enormously from the sidelines. I tried dabbling in some shorts early on, only to find the cost of maintaining them ate up all the profit and more. The Keynesian adage "Markets can remain irrational longer than you can remain solvent" seems a whole lot more real.

I enjoy your blog John, but my feeling is that you might be wrong on this one.
US regulators are however a wildcard, if it was a foreign company it would have been shut down ages ago, but...

Anonymous said...

I love david and goliath stories, but I don't remember David being so smug.

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