Institutional Option Case Study: Ackman's Investment in Herbalife

My ears perked up listening to Bill Ackman's Herbalife presentation as he talked about his use of options as an investment vehicle in his bearish investment in the company. In October 2013, Ackman informed the limited partners of his hedge fund, Pershing Square, that he had closed about 40% of his fund's short position in Herbalife (which had been suffering mark-to-market losses) and replaced it with long-dated, over-the-counter, out-of-the-money (OTM) put options.

Then, in January of this year, listed OTM put options in Herbalife saw an enormous spike in volume and pundits surmised that either Ackman was doubling down on his bearish bet, the counterparty broker was trying to "hedge out" its exposure to Ackman's investment, or that there was another investor piling in on Ackman's side.

Because this is a bearish position, there is no obligation for Pershing Square to file a form 13-D (required for investors holding more than 5% equity in a public company) or a 13-F (a quarterly listing of all stocks held by investment advisors). As such, we cannot look at detail at Ackman's put positions*, but there are some interesting insights to be gleaned from the various announcements.

Decoding the press announcements gives a good view to how a well-informed institutional investor uses options in an investing program. Let's look at three things in particular--the market in which Ackman is transacting, his strike selection, and the large listed transaction.