Put Away the Prozac, Herbalife Isn't Finished


NEW YORK (TheStreet) -- There are no conceivable ways a Herbalife investor may claim Friday's selloff was unexpected absent a lack of proper due diligence or honesty. My initial reaction was, "That's pretty convenient timing, almost exactly one hour of trading left in the week".

Any remaining doubt that puppet masters were pulling strings in symphony quickly dissipated upon further reports that federal law enforcement agencies were investigating the company. Herbalife's falling price had all the telltale indications of well-connected big money punishing shares.

HLF Chart

The leak happened on a Friday afternoon when volume is typically light, but early enough to allow time to spread via Twitter and CNBC. Once the market was in a state of worry, concern and heightened focus, the second knock-out punch came. That was the "revelation" the Justice Department and FBI are conducting investigations.

The hard-hitting precision one-two punch was enough to cause shareholders to panic and entice short-selling day traders to jump on board for an easy kill. Herbalife's bear momentum was strong enough that Nu Skin Enterprises and Avon Products  moved down in sympathy, and both finished Friday's session lower.

Bill Ackman's Pershing Square's name is plastered on Herbalife's stock Twitter thread, but Friday didn't necessarily originate there. Ackman, a hedge fund manager, may have a billion-dollar motivation to want the shares to decline, but unless he is exiting -- something he probably wants to do sooner than later -- or is preparing to exit, Friday's attack doesn't help him much, outside of mark-to-market accounting for his hedge fund.

So then, who does profit from a fall on Friday? Someone who is short and wants to get out of a position, that's who. More than 25 million shares were shorted in the company as of the last report, almost three million more than the previous period two weeks before on March 14.

Add it up, and Herbalife has a 27% or more short interest. The number of shares shorted bounces around quite a bit. Last year, around this time, more than 32 million shares were shorted, and as recently as January, about 20 million were.

Now imagine a well-financed connected short-seller with a 600,000 share short position that shorted after news broke about the Federal Trade Commission's investigation at an average of $59.

The short-seller watched the shares fall below $50, only to bounce back to above $61 in the following weeks. Now the position is underwater $1.2 million, and an attempt to exit 600,000 shares will take over a day unless the short wants to pay up and increase the loss to $2 million or more.

You or I may really sweat this situation, but not this short-seller; s/he has a get out-of-jail-free card. The short knows 20/20 is investigating Herbalife and a well-timed leak will open the doors to profit. That's exactly what we witnessed Friday.

It's not a coincidence it happened on a Friday afternoon. It's not a coincidence the worst news followed the first wave. The only real surprise is these same old tactics used by our grandparents continue to work time after time.

I'm certain the ancient Chinese General Sun Tzu would approve of the strategy and execution. He would have made a fantastic hedge fund manager. If he were here today and we could ask, I'm certain he would advise investors to use the market action to your advantage.

Options provide the vehicle to exploit market volatility. If you're long, consider selling covered calls against some of your shares. If you're considering an entry, consider selling puts instead of the shares directly.

Option buyers are eager enough to buy contracts that you can sell a put and still make money if the share price falls. For example, I posted a long Herbalife trade idea in Real Money Pro that suggested selling the August $40 puts for $5.90 before the market opened on March 21.

Even including the worst of Friday's selling, the contracts were never in the red. That's the power of adding options to your investment strategy and goals. Covered calls allow investors to tolerate larger price swings because the option acts as a hedge against price swings.

When non-economic events occur, and Friday's selloff was a non-economic event for the company, options allow for buying into uncertainty. If a Wall Street short-selling insider is buying (to cover), you can bet it's probably an ideal time for you to also.

Expect shares to remain volatile, but don't let the volatility scare you; embrace and profit from the price action while others panic.

At the time of publication, Weinstein had no positions in securities mentioned.

Follow @RobertWeinstein

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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