Update LULU: This Downward Dog Had Fleas All Over It, Closing Half Dec Put Spread

by Dan December 1, 2011 9:45 am • Commentary

-The stock is up 44% ytd, down about 24% from the all time high made in July, and up about 16% from the Oct lows.  Technically the stock is trading right below a huge resistance level at 50.00 and right below its 200 day moving avg at 50.16.  Additionally, the chart is in a fairly interesting down trend channel which has made a series of lower highs and lower lows since mid July.

1 Yr LULU chart from Bloomberg


-Street is fairly mixed on the name with 8 Buys, 12 Holds and 2 Sells.  Short interest has been ticking up of late and sits a little below 15% of the float.

-Close to 6,000 of the Dec 40 puts have traded today and most have traded on the ask signaling a Buyer to open especially when you consider open interest was only 3000 contracts on that line

-Valuation is a bit of a joke for a retailer, at 8.5x trailing 12 month sales and about 40x next year’s earnings.

Credit Suisse in a note to clients on Nov 14th regarding highlighted LULU’s exposure to the Canadian Economy at over 40% of sales:

Lululemon Highly Exposed to (a Likely Slowing) Canada (>40% of Sales, ~50% of Earnings). Canada continues to generate over 40% of Lululemon sales, and likely a greater share of profits, given maturity of stores in the region as well as higher per-door productivity ($2,500-plus, versus $1,600 in U.S.) As a result, slowing Canadian economic conditions do not bode well for future comp performance in the region, likely holding back upside potential (otherwise suggested by strong U.S. performance) near-term.

MY VIEW:  Ok I am going to try to be nice here because I like Canadians, but I generally don’t like Yogians (except my wife of course).  This is a Yoga apparel trading at 8.5x sales and 40xc earnings and is obviously priced for perfection and any whiff of slowing margins and this thing could go the way of GMCR, NFLX and CRM (all names that I was short into the print and all worked out well).  Fundamentally I have absolutely no edge, but with short interest as high as it is and given its cult stock status the only way to play the event on the short side is through options and defining your risk.  With some of the high-end retail performance we have seen in the last couple weeks out of names like RL and TIF I think it makes sense to be cautious here into their print.

The options are expensive and to make money just buying the move you would need a massive beat and raise or a decent miss.  Like I said, I have no clue, but I have to think a beat for Q3 is in the stock and any disappointment could send the stock down to the low $40s.

TRADE: LULU $49.25 Bought DEC 47.50 / 42.50 Put Spread for 1.40

-Bought 1 Dec 47.50 Put for 2.40

-Sold 1 Dec 42.50 Put at 1.00

Break-Even on Dec Expiration:

Profits btwn 46.10 and 42.50 make up to 3.60, max profit at 42.50 or below make full 3.60 (~2.5x your money)

Losses btwn 46.10 and 47.50 lose up to 1.40 and max loss of 1.40 at 47.50 or above

TRADE RATIONALE:  Like I said above, this is a strategy that has worked well for me during this past earnings season and I will continue to press given the results specially in highflying high valuation names.  The max payout on the put spread is not ideal at only about 2.5x the premium paid, but it won’t take much of a move on the downside to break-even f guidance does disappointment.   A cheaper way to do this would be with a Put Fly, but with 2.5 weeks to expiration, you could have a slightly unmanageable position on your hands if you get one of 2 things wrong, the direction and the magnitude of the move.

What I like about the Put Spread is that even if I get the direction wrong, i think in a market as volatile as this I could get a chance to get out if the we see a re-tracement of this recent broad market move prior to Dec expiration.

SO to Sum up, I have no fundamental edge, I am pressing a strategy that has worked for me this earnings season in extended names (IBM, AAPL, AMZN) and overvalued crappy names like (AMZN, GMCR, NFLX and CRM).  SO medium conviction call here, but I think if they miss then stock gets hit at least in line with the implied move.