Bill Ackman just boosted his stake in Valeant to 9.9% from 5.7%

Bill Ackman's hedge fund, Pershing Square Capital Management, has boosted its stake in Valeant to 9.9% from 5.7%, according to an SEC filing.

The firm raised its holdings to 34,118,551 according to the filing, up by 14,644,618 shares. (We'll address the dynamics of this trade a little later.)

Valeant

Valeant's stock has plunged over the past few months, putting an end to a seeming inexorable rise in the company's share price.

It moved from $26.30 October 22, 2011, to a high of $262.50 in August 2015.

But the past couple of months have been tough for the Canadian pharmaceutical company.

In September, Hillary Clinton tweeted her disdain for price gouging - or the practice of raising the price of a drug that's gone off patent. Then, short-seller Citron released a incendiary report on the company.

The stock has tumbled since.

Valeant is Pershing Square's largest holding.

The new trade

Now, Ackman and Pershing Square didn't just go to the bank, withdraw some cash, and buy stock on the market. He employed a couple of options trades, which we'll quickly address.

In summary, his new 14,644,618 shares is a combination of 2,144,618 shares of common stock and American-style call options, which he can exercise and get 12,500,000 shares. Some of these options will expire on February 8, 2016 and the rest will expire on January 20, 2017.

They're called "American-style" options because they can be exercised anytime from now until the options expire. That differs from "European-style" options, which can only be exercised at their expiration date. All things being equal, American-style options command a higher premium because of that flexibility.

Great. And now, onto the other half of the trade.

Ackman also sold European-style call options and European-style put options exposed to 12,500,000 shares. Some expire on February 8, 2016 and the rest expire January 20, 2017.

Why is Ackman selling options? Presumably, it's for the income he'll get up front for selling, or writing, those options, which - as we mentioned earlier - can't be exercised until they mature because they're European. He's probably using that income to help finance his new long position (the 2,144,618 shares of commons stock and the options). And because he sold both calls and puts, one side of that trade will offset at least some of the other side of that trade.

Here's the unedited language from the filing:

The Reporting Persons purchased for the accounts of the Pershing Square Funds a net amount of 2,144,618 shares of Common Stock and over-the-counter American-style call options referencing 12,500,000 shares of Common Stock for aggregate consideration of $475,461,812 (including commissions). In addition, the Reporting Persons sold for the accounts of the Pershing Square Funds over-the-counter European-style call options and over-the-counter European-style put options, each call and put referencing a total of 12,500,000 shares of Common Stock and received aggregate consideration of $168,966,200...

...The Reporting Persons acquired American-style over-the-counter call options referencing 12,500,000 shares of the Issuer with Expiration Dates of February 8, 2016 and January 20, 2017. In addition, the Reporting Persons sold over-the-counter European-style call options and over-the-counter European-style put options, each call and put referencing a total of 12,500,000 shares of the Issuer with Expiration Dates of February 8, 2016 and January 20, 2017. The counterparties to such over-the-counter options are Nomura International PLC and UBS AG.

So, that's hedge funds for you.