ELF’s Unusual Options Activity Is a Thing of Questionable Beauty

Short specialist Muddy Waters sent E.L.F. Beauty’s (ELF) shares on a wild ride Wednesday after announcing it was short the affordable makeup and skincare company’s stock.

While speaking at the Sohn investment conference in London, Muddy Waters CEO Carson Block said that his company had shorted ELF stock after concluding that the high-flying beauty company was overstating its revenues. 

ELF stock closed Tuesday trading at $121.75. By noon Wednesday, its shares had fallen to $102.77 by noon, one of its lowest points in the past year. However, it recovered most of the losses by the end of the day, closing at $119, down 2.3% in heavy trading. 

Its share volume was 11.7 million, nearly 4x the 30-day average. On the options front, its volume was 163,417, 6.9x its 30-day average, by far the highest single day of volume in the past year. 

It had four calls and two puts that were unusually active yesterday--I define this as Vol/OI ratios of 1.24 or higher and expiring in seven days or more--with three specific trading strategies on full display. 

Which, if any, is the best bet?

Over 50,000 Call Options  

The first strategy involves E.L.F Beauty’s two most unusually active call options. 

Both calls had volume over 25,000 and Vol/OI ratios in the hundreds. That’s a sign of some big hitters getting in on the action. To confirm this, I looked at yesterday's Options Time & Sales for the calls. The $125 and $140 strikes had 25,000 orders at 3;51 p.m. That’s 98.8% of the total volume.

This is a bull call spread.

Under the bull call spread scenario, you’re buying the $125 call at $3.90 and selling the $140 call at $0.55 for a net debit of $335. Your maximum profit in this scenario is $1,165, which is the difference between $140 and $125 ($15) less the $3.35.

Your profit probability is just 28.9%, with your maximum profit obtained if the share price is above $140 at expiration on Nov. 29.   

This is a bear call spread. 

Under the bear call spread scenario, you’re selling the $125 call at $3.00 and buying the $140 call at $1.15 for a net credit of $185. Your maximum profit in this scenario is $185, while your maximum loss is $13.15, which is the difference between $140 and $125 ($15) plus the $1.85 net credit.

Your profit probability is 68.1%, which means your maximum profit is obtained if the share price is below $126.85 on Nov. 29.   

The bear call scenario reminds me of the person who lays down a $10 bet on the most heavily favored horse at the Kentucky Derby to finish in a show (3rd position or better). While it’s likely to be in the money, the payoff is inconsequential. 

Given these two calls were at the end of the trading day, it suggests that whoever made the bet was bullish about ELF stock recovering over the next eight days. 

For $335 per 100 shares, I like the risk/reward of the bull call spread. 

The First of Two Possible Long Strangles

The strategy expects volatility to increase in the case of the long strangle. Given Muddy Waters' involvement, that’s almost a certainty. The company did come out this morning to clarify its import situation.

“In early 2024, for competitive reasons and as permitted by applicable regulations, we filed a request for confidentiality with U.S. Customs and Border Protection with respect to our customs import data. Therefore, import data available to the public after February 6, 2024, does not include a substantial majority of our actual U.S. imports,” E.L.F. Beauty’s press release stated. 

It drives me nuts when short sellers come out with accusations, and they have no consequences if they're wrong. I'm not against short selling, but I do dislike the tactics used by Muddy Waters and others. 

But I digress.

In the highlighted long strangle above, you buy a call option (Jan. 17/2025 $140) and a put option at a lower strike price (Jan. 17/2025 $95). Your net debit is $11.80, or $1,180. Your upside breakeven at expiration is $151.80, while your downside breakeven is $84. Above or below that, you’re making money. 

The Second of Two Possible Long Strangles 

The third and final E.L.F. Beauty option strategy from yesterday’s unusual options activity is the call and put expiring on Dec. 20. 

You buy the $110 call option and the $95 put in this example. Your net debit is $18.95, or $1,895. Your upside breakeven at expiration is $126.30, while your downside breakeven is $92.35. Above or below that, you’re making money. 

As I write this, this strategy is already in the money, trading around $126.56 late in Thursday morning activity. The $110 call’s ask price is $19.90, while the $95 put’s ask is $1.30, so the net debit is $2.25, or nearly 12% higher. 

This one’s a winner.   

In June 2023, I wrote the following about E.L.F. Beauty:

“Given its fiscal 2023 results were off-the-charts good, and it continues to improve its profitability -- its gross margin in fiscal 2023 (March 31 year-end) was 67.0%, 330 basis points higher than 2022 -- I see analysts upping their targets in the weeks ahead.” 

It was trading around $105 at the time, so it’s up about 20% but down significantly from its all-time high in March.

A year later, I suggested selling the Aug. 16 $185 put made sense for income and, possibly, a better entry price. It’s been downhill ever since. It appears that $98.50 on Nov. 6 was the bottom.

Barring something else from Muddy Watters that has legs, all three options strategies look to be winners.