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Herbalife Ltd. (HLF) Drama Doesn't Spook Option Bulls

Breaking down a bull call spread on Herbalife Ltd.

by 3/12/2014 12:41 PM
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Option Brief: Herbalife Ltd. (NYSE:HLF) is 5.5% higher at $69.01, despite fresh accusations from activist investor Bill Ackman. What's more, at least one options trader is rolling the dice on more upside for HLF, but is hedging his bets just in case.

Around midday, HLF has seen roughly 15,000 calls change hands -- three times the norm. A healthy portion of the action has centered on the May 67.50 and 77.50 calls, where symmetrical blocks of 3,950 contracts traded earlier today. The 67.50-strike calls crossed at the ask price of $7.60, suggesting they were bought, while the 77.50-strike calls traded near the bid price for $2.85, implying they were sold. Volume has exceeded open interest at both strikes, indicating one trader initiated a bull call spread on HLF for a net debit of $4.75 per pair of options.

By purchasing the in-the-money 67.50-strike calls, the buyer expects HLF to continue today's ascent. By simultaneously selling the higher-strike, deep out-of-the-money calls, the trader is sacrificing potential reward in order to limit risk and trim his breakeven level.

Specifically, risk on the spread is capped at the initial net debit of $4.75, compared to $7.60 for a straight call purchase. Likewise, breakeven on the spread is $72.25 (bought strike plus net debit), as opposed to $75.10 (strike plus premium paid) with the "vanilla" call. However, while a simple long call can generate theoretically unlimited profits, the maximum reward on a long call spread is capped at the difference between the strikes, less the net debit -- or $5.25, in this case, no matter how high Herbalife Ltd. (NYSE:HLF) shares should soar north of $77.50.


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