Here’s Your Opportunity to Profit From Multilevel Marketing
Multilevel Marketing (MLM) is a direct selling system. It’s a marketing strategy that eliminates the middleman by relying on a sales force to distribute the product directly to consumers. The sales reps can generally earn compensation from direct sales and from recruiting other sales reps.
This recruited sales force will then usually be called the original sales rep’s “down line.” The recruiter receives compensation for sales made by every member of their down line. They may also be compensated for recruitment. The organizational structure is shown in the diagram below.
The organization of a successful multilevel marketing organization takes on the appearance of a triangle, or a pyramid. That explains why these companies are often called “pyramid schemes.” There are many legitimate opportunities ion this sector and many find success with MLM. But, some operations do run afoul of regulators.
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Pressure on the MLM Industry
Regulators tend to question MLM operations because the focus on recruitment can lead to losses for many of the participants. In fact, studies by independent consumer watchdog agencies have shown that between 990 and 999 of every 1000 participants in MLMs lose money. That’s a startlingly high failure rate of 99.0% and 99.9% of all participants.
In the United States, regulators recently cracked down on Herbalife, one of the most visible MLM business opportunities. The Federal Trade Commission (FTC) is now mailing checks to nearly 350,000 people who lost money running Herbalife businesses.
The checks are the result of a July 2016 settlement with the FTC that required Herbalife to pay $200 million and fundamentally restructure its business. The FTC reports that it is providing partial refunds to people who ran operated franchises between 2009 and 2015, and who paid at least $1,000 to Herbalife but got little or nothing back from the company
Now, regulators in China are questioning the business model. According to CNBC, a report from China’s Phoenix New Media said four government departments will start “to carry out special rectification activities: resolutely eradicate all kinds of MLM organizations,” according to a Google translation.
Traders reacted to the news by selling shares of publicly traded MLM companies with operations in China. Sellers pushed down the price of Herbalife Ltd. (NYSE: HLF), Nu Skin Enterprises, Inc. (NYSE: NUS) and USANA Health Sciences, Inc. (NYSE: USNA).
From the News to a Trade
Market moving news will often provide an opportunity for traders and the selloffs in these three stocks provide an opportunity to review the process of moving from news to a trade. To begin with, it can be useful to quickly scan the charts of companies affected by news.
The charts of these three stocks are shown below. The charts are simple line charts because we are only looking for the most likely trade candidate at this point. A more detailed analysis will be completed in the next step in this process.
Monthly charts are shown to assess the long term trend in each stock. HLF and NUS were trading near new highs when the news from China hit. USNA was already in a down trend. That makes USNA the weakest of the three and that is the potential trade candidate to review in detail.
The charts confirm some important fundamental data. CNBC reported that about 19.6% of Herbalife’s revenue comes from China, while Nu Skin and USANA derive 29% and 52% of their sales from China. This confirms that USNA is likely to move the most on this news.
Determining a Trading Strategy
USANA Health Sciences develops and manufactures science-based nutritional and personal care products. The Company operates as a direct selling company in two geographic regions: Americas and Europe, and Asia Pacific, which includes three sub-regions: Southeast Asia Pacific, Greater China and North Asia.
Its product lines include USANA Nutritionals Essentials, Optimizers, Foods, Sense-beautiful science and All Other. Its USANA Nutritionals Essentials product line includes vitamin and mineral supplements that provide a foundation of total body nutrition for every age group beginning with children of approximately one year.
Its Optimizers product line consists of targeted supplements designed to meet individual health and nutritional needs. Its Sense-beautiful science product line includes science-based, personal care products that support skin and hair by providing topical nourishment, moisturization and protection.
This complete product line generated just over $1 billion in sales over the past twelve months. But, the rate of growth in sales has slowed from double digits a few years ago to a decline of 0.5% in the most recent quarter. Some of the decline is likely due to negative publicity about the MLM industry.
In the most recent quarter, earnings per share (EPS) dropped by 12% when compared to the same quarter a year ago. This was the third consecutive quarter of a year over year decline in EPS. Analysts expect that trend to continue. The consensus forecast is for EPS of $3.79 this year, down from $3.99 last year.
But, analysts have been overly optimistic lately. USANA has missed analysts’ expectations in each of the past three quarters and five times in the past two years. This fact helps to explain the consistent downward revisions to earnings estimates.
The financial trends point to continued pressure for the stock. This means traders should consider buying a put option on USNA. This is one of the simplest options strategies available. Buying a put can deliver a gain if the price of the stock of the declines.
The maximum amount of risk on the trade is determined when the position is opened. A trader can never lose more than the amount they pay to buy a put. The risks and rewards of this strategy are summarized in the diagram below which is taken from The Options Industry Council web site.
The maximum risk is clearly established as the diagram shows while the potential gains are rather large if a down trend develops.
However, the cost of buying put in USNA is relatively high. This is to be expected given the stock’s recent down move. An alternative to buying a put is selling a call, however this strategy creates a large amount of risk. To limit the risk, and maintain a bearish opinion on the stock, a spread can be created.
A Specific Trade
To create a spread, we can sell one call and buy another call with the same expiration date but a higher exercise price. For USNA, calls expiring on October 20 are available. These options allow nearly two months for the longer term trend to unfold.
The October 20 $60 call could be sold for about $2.40. The $65 call could be bought for about $0.95. Since each contract covers 100 shares, this trade would result in a net credit of $145 ($240 credit for the option sold less than a $95 debit to purchase the $65 call).
The maximum risk on the trade is equal to the difference in exercise prices of the two options less the premium received, or $355 on this trade. The maximum gain is the premium received, $145. This is a potential return of 41% on the amount of capital required to open the trade.
This is a significant profit, given the small amount of risk. The news will often provide leads that point to options trades such as this one that have a high potential return on investment for a small amount of capital.