The war between Carland Bill Ackman over Herbalife has been heating up, and so far is coming out on top. It's recently been disclosed that 's deploying an option strategy to increase his long leverage for less money, and it's pretty aggressive. It also reminds me of a similar situation I was in back in 1998.
What going long HLF calls (which is a long position, for all intents and purposes) and he's granting HLF puts (which is a short put position - aka a really aggressive long position in the stock). This kind of strategy is great when you're right; not only is buying calls cheaper than buying the stock outright, but granting puts brings in premium which further lowers (or even eliminates) the cost of the calls. It sucks when you're wrong, though, because then you lose on both sides of the trade.is doing is
Anyway, back in late April or early May of 1998, the annual short coffee trade was lining up. Don't ask me why this trade works each year, it just always does. But this year in particular, the options premiums on coffee were all out of whack.
Now you have to understand that I worked for a pretty plain vanilla commodities firm. And by plain vanilla I mean they'd hire pretty much anyone who could pass the Series 3 and brokers were more or less restricted to long option strategies. And this was a good thing because they weren't the brightest group of guys overall, if I'm being honest.
They weren't allowed to trade futures for clients (only futures options) and they were certainly never allowed to grant options. So research would tell us what they thought was going up or down and these guys would go buy puts or calls accordingly and hope for the best.
It never occurred to most of these guys to consider who might be on the other side of their trades. I remember asking a few of the brighter guys who they thought made all the money when their options expired worthless (which happened roughly 90% of the time). Most would shrug and assume that everyone lost everything. When I'd point out that the guy who sold them the options got to keep all the premium, I usually got a blank stare.
So everyone was pretty surprised the day Research pulled us into a meeting and advocated a short options trade. The crux of the trade was short coffee, and to that end Research was recommending that we buy July coffee puts and offset the cost by selling July coffee calls. The calls were deep out-the-money and werefor a ridiculous premium for some reason. For me the trade was a no brainer.
After the meeting one of the top guys pulled me aside and asked me to explain the trade. I went through it once and he was still pretty confused.
Him: So, wait. We're buying puts and selling calls. So the calls protect the put position, right?
Me: No. In fact this is an unlimited risk trade if it goes against us.
Him: That can't be right. They'd never tell us to do that.
Me: Well, you should only do it if you think Coffee's gonna drop. If it does, you make money on the puts and the calls expire worthless.
Him: So then don't we lose all the money on the calls?
Me: No, because you wrote the calls. The guy who bought 'em from you loses all his money.
Him: But what if Coffee goes up?
Me: Then you're fucked.
Him: This doesn't make any sense. How can you be both long and short?
Me: You're not, dude. There's short, and then there's real fuckin' short. This is real fuckin' short.
Him: You're not seriously thinking about doing this, are you?
Me: You're Fuckin' A right I am. I'm going A to Z with this shit.
Him: No way, dude. I wouldn't touch this trade. You're crazy.
Long story short, the trade worked out and set me up for a dandy summer. And it's only fair to mention that my buddy's reluctance was due in no small part to the fact that we were all personally liable for anylosses the client refused to cover. So if you buried a client for thirty or forty grand before you could cover and the client refused to pay, you'd be in a mell of a hess.
Anywho, it looks likehas decided to get real fuckin' long on HLF, which is a shame because HLF is clearly a scam and probably should get shut down but won't. The damn thing almost hit $45 on Friday, so if anything all the bad press is having a positive effect on the stock price.