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This Controversial Company Could Provide a 42% Gain

This Controversial Company Could Provide a 42% Gain

Trade summary: A bull call spread in Herbalife Nutrition Ltd. (NYSE: HLF) using the June $42.50 call option which can be bought for about $2.50 and the June $45 call could be sold for about $1.47. This trade would cost $1.03 to open, or $103 since each contract covers 100 shares of stock.

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  • In this trade, the maximum loss would be equal to the amount spent to open the trade, or $1.03. The maximum gain is $147 per contract. That is a potential gain of about 42% based on the amount risked in the trade.

    Now, let’s look at the details.

    Business Wire reported on the company’s quarterly results, results that pushed the stock higher.

    HLF daily chart

    “This quarter we delivered record volume point results reflecting the essential role our products play in the lives of many, especially during these times.” – John Agwunobi, Chairman and CEO of Herbalife Nutrition

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  • First quarter 2020 volume points of 1.6 billion increased 5.6% compared to the first quarter 2019, representing the largest quarterly volume point result in Company history.

    China volume points increased 29.4% compared to the prior year period, demonstrating a strong recovery from last year’s 100-day review.

    March worldwide volume points represented the largest single month in Company history.

    First quarter 2020 reported net sales of $1.3 billion increased 7.7% compared to the first quarter of 2019.

    First quarter 2020 reported diluted EPS of $0.32 and adjusted1 earnings of $0.83 per diluted share, compared to $0.66 per diluted share and $0.66 per adjusted2 diluted share, respectively, for the first quarter 2019, which were negatively impacted in 2020 by expenses of approximately $2.2 million, or $0.01 per diluted share, and in first quarter 2019 of $0.7 million, or $0.00 per diluted share, related to the China Growth and Impact Investment Program.

    Given the fluidity of COVID-19 and its impact on our ability to provide guidance, we are providing preliminary April volume point results, which we estimate declined 1% worldwide compared to April 2019.”

    Investors might remember HLF as a battleground stock.

    Billionaire Bill Ackman’s hedge fund, Pershing Square Capital, waged a five year battle against the company that eventually cost him an estimated $1 billion. That saga began in n 2012, when Ackman opened a massive short trade in the stock. bet against it.

    The chart below shows that eventually HLF did fall but Ackman has moved on years ago and his short position was so large the stock might have been unable to fall. After an extended basing pattern, the stock could now be ready to move higher.

    HLF weekly chart

    A Specific Trade for HLF

    For HLF, the June 19 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.

    A June 19 $42.50 call option can be bought for about $2.50 and the June 19 $45 call could be sold for about $1.47. This trade would cost $1.03 to open, or $103 since each contract covers 100 shares of stock.

    The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.

    In this trade, the maximum loss would be equal to the amount spent to open the trade, or $103.

    The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.

    For this trade in HLF, the maximum gain is $1.47 ($45- $42.50= $2.50; 2.50- $1.03 = $1.47). This represents $147 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $103 to open this trade.

    That is a potential gain of about 42% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

    A Trade for Short Term Bulls

    As with the ownership of any stock, buying HLF could require a significant amount of capital and exposes the investor to standard risks of owning a stock.

    To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.

    Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.

    To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.

    This strategy is designed to profit from a gain in the underlying stock’s price but  the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.

    bull call spread

    Source: The Options Industry Council

    Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

    This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

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