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The war between Carl Icahn and Bill Ackman over Herbalife has been heating up, and so far Icahn is coming out on top. It's recently been disclosed that Icahn'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 Icahn is doing is 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.

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 were trading for 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 any trading losses 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 like Icahn has 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.

Go figure.

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Comments (30)

  • Gekko21's picture

    Nothing fucks harder than a negative gamma position on a stock that will go into freefall. I think going long is a mistake, but shorting options is suicidal.

    "Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."

  • In reply to Gekko21
    Edmundo Braverman's picture

    Gekko21:
    Nothing fucks harder than a negative gamma position on a stock that will go into freefall. I think going long is a mistake, but shorting options is suicidal.

    In all fairness, short puts is a limited downside proposition. For example, if you write a $25 put, you know you'll never be out more than $2,500 on each one. Short calls is another story. That is truly unlimited downside.

  • UFOinsider's picture

    Edmundo Braverman:
    HLF is clearly a scam and probably should get shut down but won't

    Third world arms dealing is a shitty business too, but that doesn't make it a scam, it just makes it something you wouldn't want to have to do for a living. Bottom line, the company sells stuff through an unusual distribution system, and people can make some extra quid by recruiting into that distribution system...some people focus on just recruiting, which is a problem, but the company DOES produce something (even if substandard). Ackman is going to get completely screwed and I'm still not sure how people don't see this, least of all him: seriously, this is like shorting Microsoft because you prefer Apple.

    Get busy living

  • In reply to UFOinsider
    Edmundo Braverman's picture

    UFOinsider:
    Edmundo Braverman:
    HLF is clearly a scam and probably should get shut down but won't

    Third world arms dealing is a shitty business too, but that doesn't make it a scam, it just makes it something you wouldn't want to have to do for a living. Bottom line, the company sells stuff through an unusual distribution system, and people can make some extra quid by recruiting into that distribution system...some people focus on just recruiting, which is a problem, but the company DOES produce something (even if substandard). Ackman is going to get completely screwed and I'm still not sure how people don't see this, least of all him: seriously, this is like shorting Microsoft because you prefer Apple.

    That is an incredibly charitable view of HLF's business model. The fact that HLF produces anything is secondary to the fact that its success is predicated on continuous recruiting (aka Ponzi Scheme).

    Tupperware is multi-level marketing, and more than 90% of their product is sold to outside consumers who aren't Tupperware distributors. More than 90% of Herbalife's sales are to its own distributor network. Clearly a scam.

  • Scott Irish's picture

    I'm thinking of building a website, finding some drop shippers and a few sales people (from Craigslist, of course) and using Ackman's Herbalife slides to help build a HLF knock-off. I wonder if Ackman would front me a few mill to help bolster his $1B wager.

  • In reply to Edmundo Braverman
    UFOinsider's picture

    Edmundo Braverman:
    UFOinsider:
    Edmundo Braverman:
    HLF is clearly a scam and probably should get shut down but won't

    Third world arms dealing is a shitty business too, but that doesn't make it a scam, it just makes it something you wouldn't want to have to do for a living. Bottom line, the company sells stuff through an unusual distribution system, and people can make some extra quid by recruiting into that distribution system...some people focus on just recruiting, which is a problem, but the company DOES produce something (even if substandard). Ackman is going to get completely screwed and I'm still not sure how people don't see this, least of all him: seriously, this is like shorting Microsoft because you prefer Apple.

    That is an incredibly charitable view of HLF's business model. The fact that HLF produces anything is secondary to the fact that its success is predicated on continuous recruiting (aka Ponzi Scheme).

    Tupperware is multi-level marketing, and more than 90% of their product is sold to outside consumers who aren't Tupperware distributors. More than 90% of Herbalife's sales are to its own distributor network. Clearly a scam.


    Hey, I hate that steaming turdpile business as much as the next person, but I still see it this way. If the company required recruiting to be paid, that would be a ponzi, no question. But if people are getting paid to sell, and also paid to recruit sellers....and then focus on recruiting sellers, then it's a culture problem but not an actual rule structure problem. This is where I think Ackman's reasoning confuses one for the other.

    Theoretical analaogy: if your firm requires you to trade on inside information, that's clearly illegal. If it's not firm policy but a lot of people are trading inside information because it's easier to make money that way, then as long as the management team isn't implicated and it's not a rule, the firm is in the clear, at least from a legal standpoint. The reputational damage from such a thing can kill a firm. And just like a trading shop, there's a ton of churn, these aren't typically sophisticated relationship people, they're the get rich quick type. That's the clearest way I can explain the way I see this.

    At this point, my guess is that Ackman understands his mistake and is hoping the negative publicity will cause people to leave the company (again, not necessarily a bad thing) and therefore cause the stock price to collapse. But since Icahn's entry, and the HOLY F'ING HELL MASSIVE amount of koolade the HLFers drink, I think the company will be just fine and may even sue Ackman for slander. Depending on a number of things, Ackman could be looking at charges of manipulating the market (bogus, but easy publicity for DOJ or whatever).

    If we can't agree to disagree, let's wager?

    Get busy living

  • Edmundo Braverman's picture

    LOL. We don't disagree at all. I wouldn't touch the short side of this trade with a ten foot pole. I just happen to think it's a Ponzi scheme. But the gov't needs Joe Sixpack to have access to dreams, no matter how foolhardy, and therefore they'll never touch HLF.

  • In reply to Edmundo Braverman
    UFOinsider's picture

    Edmundo Braverman:
    But the gov't needs Joe Sixpack to have access to dreams, no matter how foolhardy, and therefore they'll never touch HLF.

    Damn, that's dark

    Get busy living

  • Markov's picture

    Wait a second, wait a second. If you buy a call and write a put, that isn't some sort of crazy thing. It's just a synthetic long position. Your returns, excepting transaction costs will very closely approximate a long position. The price you pay for the call will roughly cancel out your earnings on the put. You make money on the call when the underlying goes up and you lose money on the put when the underlying goes down. The end result is that, by buying the right quantity of stock you could get the same payout structure.

    It's a way to build up a position without buying too much of the underlying instrument for whatever reason. Nothing makes it "real fuckin' long."

  • West Coast rainmaker's picture

    I'm not touching either side of this trade. It currently hinges on government action (or inaction). And I never want my returns dependent on the arbitrary decisions of some elected official/judge. HLF is in the the pyramid-scheme gray-zone; it could go either way.

    One of my personal rules is to avoid businesses where >33% of revenue comes from the government, or where a regulatory change could potentially break the business. I will only violate the above are in the case of large defense contractors (Lockheed isn't going anywhere), and when the expected value is high enough to provide a margin of safety even when incorporating the potential for a government crackdown (De Vry).

  • In reply to Markov
    PaleBlueDot's picture

    Markov:
    Wait a second, wait a second. If you buy a call and write a put, that isn't some sort of crazy thing. It's just a synthetic long position. Your returns, excepting transaction costs will very closely approximate a long position. The price you pay for the call will roughly cancel out your earnings on the put. You make money on the call when the underlying goes up and you lose money on the put when the underlying goes down. The end result is that, by buying the right quantity of stock you could get the same payout structure.

    It's a way to build up a position without buying too much of the underlying instrument for whatever reason. Nothing makes it "real fuckin' long."

    This. The difference is that this method enables him to scale much larger, since the upfront capital is much less than buying the stock outright.

  • In reply to PaleBlueDot
    BlackHat's picture

    Aspirant21:
    Markov:
    Wait a second, wait a second. If you buy a call and write a put, that isn't some sort of crazy thing. It's just a synthetic long position. Your returns, excepting transaction costs will very closely approximate a long position. The price you pay for the call will roughly cancel out your earnings on the put. You make money on the call when the underlying goes up and you lose money on the put when the underlying goes down. The end result is that, by buying the right quantity of stock you could get the same payout structure.

    It's a way to build up a position without buying too much of the underlying instrument for whatever reason. Nothing makes it "real fuckin' long."

    This. Surprised it took this long for someone to mention it. Him being extremely long has to do with the scale, not the method.

    Yup. We've done this before and it's just the same as owning the stock but with a higher trading cost offset by the value associated with not having to actually have a huge position in the stock and putting a huge piece of capital to work. Own a call at strike X and write a put at strike X, when stock is under strike X you're out on the put and capped but out on the call, stock goes above X and you're safe on the put premium and up on the call. Same payout structure just if you size it wrong I guess then you'd end up being real fuckin' long, haha...

    I hate victims who respect their executioners

  • In reply to Markov
    Boothorbust's picture

    Markov:
    Wait a second, wait a second. If you buy a call and write a put, that isn't some sort of crazy thing. It's just a synthetic long position. Your returns, excepting transaction costs will very closely approximate a long position. The price you pay for the call will roughly cancel out your earnings on the put. You make money on the call when the underlying goes up and you lose money on the put when the underlying goes down. The end result is that, by buying the right quantity of stock you could get the same payout structure.

    It's a way to build up a position without buying too much of the underlying instrument for whatever reason. Nothing makes it "real fuckin' long."


    Thank you! This is not some juiced up long - it's synthetic ownership. The net cost of this position should approximate the financing costs of going traditionally long via physical shares.
  • In reply to BlackHat
    PaleBlueDot's picture

    BlackHat:
    Aspirant21:
    Markov:
    Wait a second, wait a second. If you buy a call and write a put, that isn't some sort of crazy thing. It's just a synthetic long position. Your returns, excepting transaction costs will very closely approximate a long position. The price you pay for the call will roughly cancel out your earnings on the put. You make money on the call when the underlying goes up and you lose money on the put when the underlying goes down. The end result is that, by buying the right quantity of stock you could get the same payout structure.

    It's a way to build up a position without buying too much of the underlying instrument for whatever reason. Nothing makes it "real fuckin' long."

    This. Surprised it took this long for someone to mention it. Him being extremely long has to do with the scale, not the method.

    Yup. We've done this before and it's just the same as owning the stock but with a higher trading cost offset by the value associated with not having to actually have a huge position in the stock and putting a huge piece of capital to work. Own a call at strike X and write a put at strike X, when stock is under strike X you're out on the put and capped but out on the call, stock goes above X and you're safe on the put premium and up on the call. Same payout structure just if you size it wrong I guess then you'd end up being real fuckin' long, haha...

    What are your 2c on this whole thing anyway? I have zero interest in actually trading on it, but it's an interesting debate. I listened to much of Ackman's presentation and there were a few "wait...really? ...really?" moments, like recognizing list price as revenue (how would that ever get past any audit?). Granted that's more an accounting irregularlity than stand-alone evidence of a pyramid scheme, still struck me as almost too blatant of a thing, if it's true.

  • In reply to PaleBlueDot
    BlackHat's picture

    Aspirant21:
    BlackHat:
    Aspirant21:
    Markov:
    Wait a second, wait a second. If you buy a call and write a put, that isn't some sort of crazy thing. It's just a synthetic long position. Your returns, excepting transaction costs will very closely approximate a long position. The price you pay for the call will roughly cancel out your earnings on the put. You make money on the call when the underlying goes up and you lose money on the put when the underlying goes down. The end result is that, by buying the right quantity of stock you could get the same payout structure.

    It's a way to build up a position without buying too much of the underlying instrument for whatever reason. Nothing makes it "real fuckin' long."

    This. Surprised it took this long for someone to mention it. Him being extremely long has to do with the scale, not the method.

    Yup. We've done this before and it's just the same as owning the stock but with a higher trading cost offset by the value associated with not having to actually have a huge position in the stock and putting a huge piece of capital to work. Own a call at strike X and write a put at strike X, when stock is under strike X you're out on the put and capped but out on the call, stock goes above X and you're safe on the put premium and up on the call. Same payout structure just if you size it wrong I guess then you'd end up being real fuckin' long, haha...

    What are your 2c on this whole thing anyway? I have zero interest in actually trading on it, but it's an interesting debate. I listened to much of Ackman's presentation and there were a few "wait...really? ...really?" moments, like recognizing list price as revenue (how would that ever get past any audit?). Granted that's more an accounting irregularlity than stand-alone evidence of a pyramid scheme, still struck me as almost too blatant of a thing, if it's true.

    I've never done any real work on HLF but everyone's glazed over it at least once or twice by now so my take on it is that like any other MLM the business inherently can't last long-term and it's not something I'd ever want to be a part of, but at the same time Ackman is just sitting there basically hoping the FTC will step in and announce an investigation. That's not much of a catalyst for a conviction investor in my opinion. And he's said before that if the FTC did investigate and they came away saying HLF wasn't a pyramid scheme by their definition, then he'd lobby Congress to change the law because he thinks it's "morally wrong" or some bullshit like that. Sounds like a qualification of his conviction, though from what I've seen so far nobody's done anything to even remotely shoot down Pershing's arguments. The fact that being short on this is a time-sensitive issue and everyone knows Ackman's putting himself out there all alone is also pretty scary, so while I'd never go long on HLF, I'd never go short. I'm not really sure what Icahn or even Loeb would be thinking going long other than the fact that Ackman's on the other side. I really really doubt they had a long-standing consensus over at Third Point among the analysts that "if HLF ever gets back down to the 40s, we need to scoop up 8% of that fantastic business and sit on it." Nobody's investing on this business's actual operations.

    I hate victims who respect their executioners

  • In reply to PaleBlueDot
    BTbanker's picture

    Aspirant21:
    BlackHat:
    Aspirant21:
    Markov:
    Wait a second, wait a second. If you buy a call and write a put, that isn't some sort of crazy thing. It's just a synthetic long position. Your returns, excepting transaction costs will very closely approximate a long position. The price you pay for the call will roughly cancel out your earnings on the put. You make money on the call when the underlying goes up and you lose money on the put when the underlying goes down. The end result is that, by buying the right quantity of stock you could get the same payout structure.

    It's a way to build up a position without buying too much of the underlying instrument for whatever reason. Nothing makes it "real fuckin' long."

    This. Surprised it took this long for someone to mention it. Him being extremely long has to do with the scale, not the method.

    Yup. We've done this before and it's just the same as owning the stock but with a higher trading cost offset by the value associated with not having to actually have a huge position in the stock and putting a huge piece of capital to work. Own a call at strike X and write a put at strike X, when stock is under strike X you're out on the put and capped but out on the call, stock goes above X and you're safe on the put premium and up on the call. Same payout structure just if you size it wrong I guess then you'd end up being real fuckin' long, haha...

    What are your 2c on this whole thing anyway? I have zero interest in actually trading on it, but it's an interesting debate. I listened to much of Ackman's presentation and there were a few "wait...really? ...really?" moments, like recognizing list price as revenue (how would that ever get past any audit?). Granted that's more an accounting irregularlity than stand-alone evidence of a pyramid scheme, still struck me as almost too blatant of a thing, if it's true.


    Remember, the SEC, historically, has done an awful job at finding fraud when it's right in front of them.
  • BTbanker's picture

    Why are you guys afraid of a short?

    1. Icahn announces a 12% stake, and the stock goes NOWHERE. That says something.
    2. Loeb reduced his position in HLF. Called that one.
    3. Any position Einhorn holds is one I hold. Ackman, meh, ok.
    4. You all KNOW its fraud, and if the govt doesn't call them out, the market will.

  • In reply to BTbanker
    PaleBlueDot's picture

    BTbanker:

    Fair point, I think we're generally talking about the FTC in this case though. To BlackHat's point, he did reference the Madoff/SEC blunder with the whole "if you knew about madoff and didn't say anything that'd be a moral mistake so I have to shout this HLF thing from the rooftops because low income people are getting swindled". In this whole thing, I definately have to give Ackman the nod on actually being a composed, professional person, where Icahn was just a lunatic during that cnbc exchange.

    Considering it's a pretty massive company, I'm pretty blown away at how poor of a job it's done defending itself. The CEO interviews were just awful, and they haven't released (at least during said interviews) any sort of statistics that counter Ackman. Every time the CEO has addressed a certain attack its been like "oh it's 90%...ish...we don't really track these things."

    "Why are you guys afraid of a short?

    1. Icahn announces a 12% stake, and the stock goes NOWHERE. That says something.
    2. Loeb reduced his position in HLF. Called that one.
    3. Any position Einhorn holds is one I hold. Ackman, meh, ok.
    4. You all KNOW its fraud, and if the govt doesn't call them out, the market will."

    We know it's a god awful "business opportunity", which you would expect at the very least to lead to some fines or something for misleading prospective distributors - I don't have enough exposure to know how common this is for MLM's, seems like they generally lie their ass off about what a "normal" rep can earn. Outright fraud? Still up for debate it seems.

  • In reply to West Coast rainmaker
    UFOinsider's picture

    West Coast rainmaker:
    One of my personal rules is to avoid businesses where >33% of revenue comes from the government, or where a regulatory change could potentially break the business.

    I like this

    Get busy living

  • BTbanker's picture

    Many people categorize every MLM as a pyramid scheme, and sure there's money to be made short term (read: johnson made 90mm last year); however, while Icahn won't say it, he's long just to spite Ackman. We all know it. He's only hoping someone will buy HLF, or the govt turns a blind eye. If you saw the earnings transcript of Lehman just before they went under, you know the party can come to an end real quick.
    http://dealbreaker.com/2013/02/carl-icahn-wont-say...

  • In reply to BTbanker
    Edmundo Braverman's picture

    BTbanker:
    Many people categorize every MLM as a pyramid scheme, and sure there's money to be made short term (read: johnson made 90mm last year); however, while Icahn won't say it, he's long just to spite Ackman. We all know it. He's only hoping someone will buy HLF, or the govt turns a blind eye. If you saw the earnings transcript of Lehman just before they went under, you know the party can come to an end real quick.
    http://dealbreaker.com/2013/02/carl-icahn-wont-say...

    LOL. Yeah, I don't think anyone is long because they think it's a great company.

  • In reply to BTbanker
    BlackHat's picture

    BTbanker:
    3. Any position Einhorn holds is one I hold

    Good logic

    I hate victims who respect their executioners

  • In reply to BTbanker
    BlackHat's picture

    BTbanker:
    BlackHat:
    BTbanker:
    3. Any position Einhorn holds is one I hold

    Good logic


    He jumps, I jump.

    I hate victims who respect their executioners

  • In reply to BlackHat
    BTbanker's picture

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    Metal. Music. Life. www.headofmetal.com