The Mysterious Life of Herbalife Options

Part of Carl Icahn’s big reveal in yesterday’s 13F filing was that he acquired a 12.8% stake in Herbalife (HLF) which initially sent the stock some 20% higher. But as options guru Jon Najarian pointed out on CNBC and his blog that the cagey raider seemed to make use of options to further leverage and pressure his position.

It is cited that Icahn bought 83,117 calls with a $26 strike that expire on January 28, and also purchased 32,300 of the $23.50 calls that expire on May 10 of this year. This may in fact give Icahn a notational interest of some 11 million shares as the calls are very much in-the-money and can be exercised at any time. Icahn may be even more cagey and sophisticated than Dr. J. gives him credit for, and it may not be as bullish as it seems.

First, it needs to be understood that unlike a purchase of the underlying stock, in which there is a limited number of shares, a spike in price would be net value creation. The options market is a zero-sum game as contracts only come into existence when there is a willing buyer and seller, and there is no limit to the number of contracts that can be created.

With that in mind, note the two call series cited as being purchased by Icahn are not traditional exchange listed, the expiration dates fall outside of current listings, meaning they are flex options -- perfectly legitimate, but it suggests that the contra-party or seller is just as sophisticated as Icahn, and more than likely hedged the sale of the calls at the time of the transactions. Further evidence that these were custom over the counter contracts is that Options Clearing Corp. shows no volume or open interest in any HLF flex options.

The “private placement” may explain why the stock not only dropped in the days following the initial Ackman vs. Icahn public war of words when the accumulation of calls probably took place but also subsequent flat lining until last night’s 13D release.

It may also explain why the stock has slipped significantly off its initial highs, and it's now up just 4%. As people dove deeper into Icahn’s’ position, the realization may be that even a rich and cagey coot may not be ready to exercise $400 million worth of stock just out of spite. He pretty much proved his point and still holds plenty of leverage. And in this high stakes game, options can be great way to hide your actual hand or intention.