NEW YORK (TheStreet) -- Shares in the nutritional supplement company Herbalife (HLF) soared over $6 a share to near 52-week highs after revealing its new auditor PricewaterhouseCoopers finished re-auditing the company's 2010 to 2013 financials.
The very public Herbalife short seller Bill Ackman has allowed a significant gain for his hedge fund Pershing Square turn into a horror-show short squeeze. A couple of months ago, I touched on Pershing Square's lack of gains for the year as a result of the monster short position. Things have only turned worse since.
On Tuesday, shares in the company reached a new all-time high trading near $78.50 a share. According to a copy of Pershing Square's investment letter to shareholders for the period ending Sept. 30, the amount of capital dedicated to Herbalife's short position is about 12% of funds, and the hedge fund has about $11.2 billion under management. If the position isn't leveraged, we can extrapolate a short position size of $1 billion or more after adjusting for redemptions. The numbers also appear correct based on Ackman's comments.
On Sept. 30, Herbalife closed at $69.77 a share, and if we use a current price of $77, the position lost another 10.3%, or $103 million, in under three months. It becomes even more intriguing when calculating the difference between the closing price of $32.94 on Dec. 31, 2012, after the shares were hammered by Ackman's presentation.
For those playing the home game, that's an appreciation of 133%, even more if you look at the low of the day. There's an old saying on Wall Street that you should never let your winners turn into losers. A stop loss at breakeven would have saved Ackman (and Pershing Square's investors) a lot of grief in 2013. The position has nearly the same amount of maximum profit had the shares continued to zero. After adjustments including option premium time loss, the current unrealized loss may exceed the total potential profit.
Will Herbalife retrace 2013's gains and continue lower until it reaches $0? Not likely. If the FTC and or other government agencies decided to play hardball, they're in no position to steamroll a $7.7 billion multinational corporation with thousands of employees and millions of independent distributors. If government agencies intended to put a dog into this fight, they would have likely done so by now.
The NYPD Hispanic Society called for New York State Attorney General Eric Schneiderman to investigate Herbalife. It's safe to say it will to take considerably more for Carl Icahn to become nervous that he may wake up and find the company on the pink sheets.
It shouldn't surprise anyone though that he may call this one good and ring the register, at least in part. I advised investors to do the same in early October. Icahn covered part of Netflix (NFLX) for the same reason Ackman should have when Herbalife shares were trading under $30; to protect some gains.
If you're not sure about timing a sale of some shares to lock in gains, consider using options to do it for you. The January $77.50 calls are trading for about $5 a contract. If you sell this contract against your shares and the stock continues to appreciate, your gain is capped at $82.50. If you're willing to take $82.50, an option hedge makes a lot of sense. You lower your risk, and you don't take the gain until next year.
I especially like it because if the shares decline, or are not above $77.50 at the expiration, the covered call writer keeps the entire premium and can sell options again.
At the time of publication, Weinstein had no positions in securities mentioned.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.