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Investor Places Bullish Debit Spread on Herbalife Ltd.

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On the option exchanges, there is one investor who clearly thinks HLF is going higher

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Herbalife (NYSE:HLF) is a rather controversial stock that has made the news a lot over the past year or so. If you have been following the news at all, then you likely know that hedge fund giants like George Soros and Carl Icahn own large positions, while Pershing Square's Bill Ackman publicly announced that he had a short position, calling the company a "pyramid scheme." In essence, there has been a lot of hype surrounding this name -- and the stock has really been on a tear this year as it has more than doubled (as of yesterday's close, 9/9/13).

Featured below is a chart of the stock. Ackman is certainly experiencing some pain with his short position as the shares keep going seemingly every day. On the option exchanges, there is one investor who clearly thinks HLF is going higher -- and a bet was placed via a bullish debit spread. Let's take a look at this trade and see what the profit potential amounts to.


Chart courtesy of stockcharts.com

The following information is from Trade Alert. These were some of the top trades that went off yesterday.

Top Option Trades
HLF 65.51 +1.76 close
>> 100 HLF Jan14 105 Calls trade $1.10 MID
>> 100 HLF Jan14 95.0 Calls trade $1.74 MID

There appears to have been a series of 100 lot debit spreads initiated on HLF for the January, 2014 95-105 call options. Take a look at the most active stock options for the day. The 95-strike and 105-strike calls traded just over 1,000 times.

Most Active Stock Options
HLF 65.51 +1.76 close
>> 1035 HLF Jan-14 95.0 C 97% Mid
>> 1010 HLF Jan-14 105.0 C 100% Mid

It is likely that this particular investor did roughly 10 different debit spreads throughout the day, and therefore paid slightly different prices for each trade. The differences in the total debit are minor (and really besides the point), but we are going to use the prices for the 100 lot that I showed before this list of most active options.

The 95-strike calls were purchased for $1.74, while the 105-strike calls were sold for $1.10. This resulted in a net debit to the trader's account of $0.64 ($1.74-$1.10). For the 95-strike call to be in-the-money (ITM), we need HLF to make a pretty substantial move by January expiration -- a 45% move, to be exact (based on the close of 65.51). The breakeven level is simply the strike price that was purchased plus the total debit -- $95.64. Any price above that, and we start achieving gains.

Now, what is the max profit potential? Since the 105-strike has been sold, the investor's gains are capped at this level. If HLF is trading above 105 by January expiration, then the options that this trader is short (the ones sold) can be assigned at the strike price. If HLF happens to be trading at $105 exactly by January expiration, then the investor stands to take in a pretty sizable profit of $9.36 for each contract. How did I get this number? I simply took the intrinsic value of the option purchased (95-strike, so worth $10 if HLF is at $105), and subtracted the cost for each spread -- $0.64.

In essence, the investor/trader is making a bet that HLF can move as far as $105 by January 18, 2014 (expiration day), but will not surpass this level. It's a fairly "low-risk" trade with some huge profit potential. However, it's going to take a monstrous move for the stock to get there.

This article by Peter Bryans was originally published on Schaeffer's Investment Research.

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Twitter: @schaeffers
No positions in stocks mentioned.
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