REUTERS/Brendan McDermid
According to an investor letter released late last night, Ackman's Pershing Square swapped more than 40% of its equity short position in Herbalife for put options.
With those puts, Ackman will profit if the stock declines below his strike prices. He will only lose a little bit per share if the stock stays at the same level or goes up.
Bottom line, though, Ackman has just changed the payout profile for this trade.
But Ramey points out that one huge downside from Ackman's move is that he will run out of time and the puts will expire worthless for Pershing.
He also thinks that the over-the-counter (OTC) desk that sold Ackman the puts is going to be "very lucky."
From Ramey's note (emphasis ours):
Pershing Square buys out-of-the-money puts. Pershing likely bought out-of the-money (e.g., $37.50 strike price, at half HLF's current price) puts covering 10 million shares (100,000 puts if conventional 100 multiplier of listed puts) from a very lucky counterparty. We say lucky because it is highly likely that these puts will expire worthless and Pershing's counterparty will get to pocket the price of the puts at a time when the implied volatility is at historically unprecedented levels.
Again, Ramey re-emphasizes this.
This new bearish position seems at odds with Pershing Square's goals. If it truly still believes the go-to-zero thesis, and Mr. Ackman writes in his letter that he does, then it makes no sense to put a time element into this trade. He now needs to be both right on the go-to-zero thesis and right on the timing. On one thing we do agree - Pershing Square has significantly reduced the risk of unlimited losses, but has increased the certainty of a total loss of the original $1 billion short position as the puts expire worthless. The counterparty to his trades indeed has a winning hand.
Herbalife's stock was last trading down more than 7%.