LULU Q3 Earnings Preview and Stock Alt

by riskreversal December 5, 2016 1:23 pm • Trade Ideas

Athleisure stocks are ripping today with Lululemon (LULU) leading the way, up 4%, Nike (NKE) up 3% and Under Armour (UA) up 2.5%.  All three stocks are well off of their 2016 highs though, with LULU down 30%, NKE down 24% and UA down 35%. LULU is the only one in the group that is actually up on the year. LULU reports their fiscal Q3 results on Wednesday after the close. The options market is implying about a 9% one day move in either direction on Thursday, which is a tad shy of its 4 qtr and average since their 2007 IPO of about 10%.

Since the stock’s epic collapse in early September, LULU has found some support at $55, having bounced from that level on 5 occasions since mid October, but also finding some resistance in the high $50s:

LULU 1yr chart from Bloomberg
LULU 1yr chart from Bloomberg

Trying to get a sense for sentiment into the print is nearly impossible if you’re just looking at the newswires:


And Wall Street analyst ratings are not much more help with 16 Buys, 13 Holds and 6 Sells. Pretty mixed. As one would expect short interest is down from its Sept levels, now about 15%, while 30 day at the money implied volatility (the price of options) is creeping up, approaching the 2016 highs prior to results:

LULU 1yr chart of 30 day at the money implied volatility from Bloomberg
LULU 1yr chart of 30 day at the money implied volatility from Bloomberg

One thing is fairly certain though, for as high as expectations might have been prior to LULU’s fQ1 results on Sept 1st when the stock was very near the 52 week highs, they may be low, relative to the guidance they gave for the current quarter, the stock’s precipitous decline, and most importantly the commentary the company gave on the call, per Motley Fool:

Lululemon CEO Laurent Potdevin noted that this quarter marked “an important inflection in our gross margin and earnings performance.”

Potdevin elaborated, “Our progress in the second quarter, especially in gross margin and inventory, marks the beginning of our recovery in profitability and sustainable long-term growth.”

I suspect the tight range the stock has been in for the last two months is broken one way or the other following Wednesday’s results.

So What’s the Trade? 

LULU certainly looks like a chart that could be bottoming. But the stock has shown massive volatility in the past and defining risk for those looking to play for a breakout from the range is the smart move.

Defined Risk Stock Alternative in lieu of 100 shares of LULU (57.75)

LULU (57.75) Buy the Jan 57.50/67.50/77.50 call fly for 2.50
  • Buy 1 Jan 57.5 call for 4.50
  • Sell 2 Jan 67.5 calls at 1.10 (2.20 total)
  • Buy 1 Jan 77.5 call for .20

Rationale – This trade defines risk to just 2.50. That’s less than half the event risk in the stock itself with a $5.50 implied earnings move either way. On a big move lower this will suffer losses but it’s unlikely to be worthless and is much better than being long stock. On a move higher the ideal situation is for the stock to be at or near 67.5 on Jan expiration. A move higher and not all gains are realized obviously, so patience is a virtue. But it will be a nice winner anywhere above it’s break-even point and vol will come in hard which will help with gains above the break-even.

For those that are less ambitious on the upside and want to lower that break-even, the Jan 55/65/75 call fly is 2.90 with a break-even basically where the stock is currently trading. This will see better gains on a smaller move higher but it also lowers the maximum gain level to 65, which is a dollar below the 200 day moving average. And breakout above that and the 55/65/75’s profits trail off. Both trades are good as an alternative to stock with similar risk if the stock collapses, but which strikes depends on what area to target on the upside and how close you want the break-even.