Hedge funds have been lining up on both sides of the fence
regarding nutritional supplement multi-level marketing company
Herbalife Ltd. (
HLF
)
. Thestock made a52-week high of $73 last spring beforeshares took
a huge hit following accusations fromhedge fund investor William
Ackman that the company was nothing more than a pyramid scheme.
The seven-month trading range between $56 and $42 a share
projected a downside target of $28 ($14 height of the pattern
subtracted from the breakdown level of $42). A volatility spike
occurred when the downside channel support at $42 was broken in
December, and as often happens at price extremes, the selling
pressured the stock to $24 before a rebound.
Recent action has seen the price rally back above breakdown
point at $42, which acts as the pivot point, to about $44. As the
battle between short sellers and value buyers continues, traders
can use a different approach toprofit from Herbalife.
Because of the high volatility, another word for opportunity,
the options on the stockoffer many strategies with mathematical
advantages over a straight purchase of the shares. In particular,
sellingput options could allow us to collect income while we wait
to get into the stock at an even bigger discount.
Cash-Secured Put Selling Strategy
While the typical investor might use alimit order to buy a stock
orexchange-traded fund (
ETF
) at a designated price or lower, the options trader can do one
better by selling a cash-secured put.
This strategy has the same mathematical risk profile as acovered
call . With put selling, there is anobligation to buy the stock at
thestrike price if it is assigned, allowing you to get into the
stock at a discount. In fact, the true entrycost basis is even
lower with the subtraction of the premium you earned from selling
theputs .
And if the stock is not below the strike price atexpiration ,
then the premium received is all profit. In other words, you're
getting paid not to own the stock.
There are two rules traders must follow to be successful at
selling put options.
Rule One: Only sell puts onstocks you want to
own.
The intention of this strategy is to be assigned the stock as a
long-terminvestment (eachoption contract represents 100 shares). So
make sure you have thefunds in your account to buy the stock at the
options strike price if a sell-off continues. Paying in full
ensures that no additionalmoney is needed to hold the stock for
potentially many months or even years until a price recovery.
Rule Two: Sell either of the front two option expiration
months to take advantage of time decay.
Collect premium every month on put sales until you are assigned
shares at a cost-reducedbasis . Every month that you keep the
premium is money subtracted from your entry price.
Action to Take -->
Sell to open HLF Feb 30 Puts at $1 or better.
This cash-secured put sale would assign long shares at $29 ($30
strike minus $1 premium), which is about 34% lower than Herbalife's
current price, and would cost you $2,900 per option sold. Remember:
Only sell this put if you want to own Herbalife shares at a
discount to the current price. If you are assigned the shares, a
March covered call can be sold against the stock to lower your cost
basis even further.
And if the stock does not fall below the strike price before
expiration, then you keep the premium you collected, essentially
getting paid not to buy the stock.
This article originally appeared on ProfitableTrading.com:
This Controversial Stock Could be the Ideal
Income Generator