Name That Trade – $UA: Under Ammo

by CC September 17, 2015 12:12 pm • Commentary

Earlier today (here), Dan  took a look at the phenomenon that is Under Armour (UA) . It’s one of the first large cap stocks in our market to not only retake its 2015 highs but also (yesterday) close at a new all time high.  Dan did a little comparative valuation with Nike (NKE) and concluded:

And with the torrid gains has come a very healthy valuation with the stock trading 95x expected 2015 earnings growth of 14% (down nearly 50% from fiscal 2014), and 5.75x expected 2015 sales growth of 26% (down from 2014’s 32% growth).

For comparison sake, Nike’s (NKE) market cap is about 4x that of UA, have about 9x the expected sales, that are only growing mid single digits, but trades 27x expected fiscal 2016 earnings that should grow 13% Obviously a much larger and mature company that still has impressive growth, but also a premium valuation.

So if we were playing would you rather, NKE or UA, its a fairly tough call. Both stocks are priced for perfection in this environment. For those that would chose UA, I suspect the focus will be on the potential for greater international growth. UA currently has less than 10% of its sales from outside the U.S., which is one reason they are betting the farm on NBA superstars like Steph Curry (resigned yesterday). International expansion could be the key to UA growing into a sort of NKE valuation in the years to come. While the strength of the dollar will be a headwind for NKE, as they get more than 50% of their sales from outside North America, incremental sales for UA will be less of an issue despite the potential of lower profitability in other regions.

We’ve had a few questions on this one and we wanted to demonstrate a way to participate in further upside (or even sideways action) in a stock that is already in uncharted territory. Dan wants to use technicals as a guide, as things like valuation and decelerating growth have yet to deter bulls:

The extreme stock market weakness in August revealed some technical support levels in many stocks. For instance UA’s August 21st close, the Friday before the flash crash on the Monday, was $90. the exact level the stock broke out from to new all time highs in late July after a beat and raise quarter (blue line). While the stock’s panic low on Monday morning August 24th was $80 (green line) now looks like very healthy long term support:

UA 1yr chart from Bloomberg

With short dated options prices elevated it makes sense to avoid long premium directional strategies.  Here is how we would set limit orders below the market in UA targeting the levels highlighted above:

If you were considering a buy of 100 shares of UA at the current price of  $104.80. You might prefer selling 1 Oct 30th weekly 92.50 put (will catch UA’s next earnings) at $2.25, taking in $225 in premium.  The Oct 30th 92.50 put has a 21 delta, the options market is saying there is a little more than 20% chance this option is in the money on Oct 30th expiration. If the stock was $92.50 or below on Oct 30th expiration you would be put 100 shares of stock at $92.50, but effectively $90.25, down 14%.  If the stock is above $92.50 you make the $225.

Another option is selling a longer dated, lower strike put. For instance, with the stock at $104.80 you could sell the Jan16 85 put at $2.50, taking in $250 in premium.  The Jan16 85 put has a 17 delta, the options market is saying there is a about a 17% chance this option is in the money on Jan16 expiration. If the stock was $85 or below on Jan16 expiration you would be put 100 shares of stock at $85, but effectively $82.50, down 21%. If the stock is above $85 you make the $225.

What can then be done following the put sale is to possibly time a corresponding call buy either on a pull back in the stock or if implied vol came in a little. You’d then have a riskreversal on very cheap with identified levels on the downside where you’d be willing to be long the stock and upside similar to stock above your call strike. (we’ll revisit this idea if either of those happens with another post)

So what we have done here set limit orders down at identifiable technical support levels which we, and options market makers would be very surprised to see in the money.  While these options have fairly low deltas, the recent rise in implied volatility has made them attractive sale candidates for those who want to have some skin in the game but are apprehensive to chase the stock here.

It is important to remember that high priced options look attractive sale candidates until there are not. If the broad market were to get crashy again, and a stock like UA that has been a fairly crowded trade, begins to re-test the levels from late August, then being short downside puts will not be comfortable. But there will be plenty of time to take the trade off for a small loss unless we see an actual crash. I can assure you it will be a better way to have long exposure than buying the stock at the all time highs. Plus, these levels need to be places where you are willing to buy the stock anyway. And remember, being short puts requires margin like stock from that level.

We are NOT chasing UA here, but for those inclined to start picking away at the stock, or happy to buy on pullbacks, this is one way to leg into a long.