Name That Trade $LULU: Options Prices Lack Flexibility

by Dan June 8, 2015 10:44 am • Commentary

Event: Lululemon (LULU) reports fiscal Q1 results tomorrow before the open, the options market is implying about an 8.5% one day move*, which is shy of the 4 qtr average of about 11% and the 8 qtr average of about 10.50%.

With the stock at $63, the June 12th weekly 63 straddle (the call premium plus the put premium) is offered at $5.50, if you thought the stock could move greater than 8.5%but was unsure of the direction and bought the straddle, thus the move, you would need a rally above $68.50, or below $57.50 to make money on or by Friday’s close.

Price Action / Technicals: The stock is up 13% year to date, despite being down 10% from the 52 week highs made in early April.  LULU has spent most of 2015 between $60 and $70 with its average for the period of about $64.

The chart has been in a downtrend since the highs, making a series of lower highs and lower lows.  The stock’s recent bounce of 9% in the last 5 trading days came to a halt right at the downtrend, and just below the 50 day moving average (purple below):

LULU ytd chart from Bloomberg
LULU ytd chart from Bloomberg

On the upside, the prior high of $70, just above the implied move should serve as staunch technical resistance.  While the stock’s recent consolidation in and around $60 should serve as mild technical support, while the stock’s 200 day moving average (yellow above) at $55 should be a place where the stock would pause on a miss and guide down.  

My View: Back in Mid April I was bearishly positioned in LULU (read here), as I felt:

The company suffered from a series of misfires in 2014, but has seemingly righted the ship. But here is the problem. The stock’s recent gains (up 20% on 2015 already) more than compensates for renewed enthusiasm as the stock is trading at 35x expected fiscal 2016 earnings growth of 15%. Especially when you consider that massive NKE trades 25x expected fiscal 2016 earnings growth of 12%.  NKE reported earlier this week that they are becoming very focused on women and are committing serious resources to increase sales of women’s apparel by $2 billion by 2017.  What’s interesting to me about that $2 billion number, that is equivalent to LULU’s expected sales this year.

Nothing has changed here, aside from volatility in the stock on no news, and while I got the timing of the sell off wrong (closed for a loss prior to May expiration, here), I may have another shot given the stock’s recent bounce.

I am looking at ways to fade the recent rally, I am not sure I want to fade the implied move given the stock’s fairly wide range in 2015 and the stock’s propensity to move.

If I were to play for a break of $60 on earnings, with the stock finding support at $55 I would consider the following bearish trade:

LULU ($63) Buy June 19th 63/55 put spread for 2.50, break-even at $60.50, down 4%, with max gain of $5.50 down to 55.

Or, if I thought the stock could continue the recent bounce, but find sellers at $70 I would consider the following bullish trade:

LULU ($63) Buy June 12th weekly 63/70 call spread for 2.40, break-even at $65.40, up about 4%, with a max gain of up to $5.60.

As always we are weary of long premium directional options trades into events like earnings as there are a lot of things you need to get right to just break-even, direction, timing and magnitude of the move.

At this point I lack conviction into the event and will likely take a pass, but would be inclined to fade a move higher after the results if guidance was enough, but squishy.