How to Play the Lululemon Collapse

by Tyler Craig | March 19, 2013 11:29 am

How to Play the Lululemon Collapse

Shares of Lululemon (NASDAQ:LULU[1]) are getting hit today in response to news that the popular apparel company is recalling approximately 17% of women’s yoga pants[2] in its stores. The recall led the company to downshift revenue expectations for the first quarter to between $333 million and $343 million, from a prior range of $350 million to $355 million.

Despite a roaring stock market, LULU has now fallen over 18% for 2013. Let’s take an in-depth view of the charts to see what the future may hold for the beleaguered retailer.

LULU chart 300x209 How to Play the Lululemon Collapse
Click to Enlarge

LULU has essentially been dead money for the past six months, stuck between resistance at $78 and support at $65. Today’s gap lower took out the $65 level decisively, resulting in an ugly breakdown. As suggested in the charting principle of polarity — old support becomes new resistance — we should now expect the $65 zone to act as major resistance in the future.

From a longer-term perspective, the next major support level is $55 — which means LULU has room to run to the downside if the selling pressure continues.

Be aware that LULU is set to report earnings Thursday before the market opens. Earnings announcements typically spark a large move in this stock, but I suspect with the company already hinting at lower-than-expected revenue and same-store sales, the disappointing cat is already out of the bag.

If you expect LULU will continue its slide in the coming weeks, consider one of these option plays.

Sell the April 65-70 bear call spread for $1.40. The max reward is limited to the initial $1.40 received and will be captured if LULU remains below $65. The max risk is limited to the distance between strikes minus the net credit, or $3.60. This strategy fits nicely with the view that LULU will be unable to climb back above $65 in the next few weeks.

A more aggressive yet potentially more lucrative bet is to purchase the June 60-55 put spread for $1.75. The max risk is limited to the initial $1.75 paid and will be lost if LULU remains above $60 by June expiration. The max reward is limited to the distance between strikes minus the net debit, or $3.25, and will be captured if LULU falls to its next support level at $55. Using June options gives plenty of time for LULU to make the expected trek lower.

At the time of this writing Tyler Craig had no positions in LULU.

Endnotes:
  1. LULU: http://markets.financialcontent.com/investplace./quote?Symbol=LULU
  2. 17% of women’s yoga pants: http://investorplace.com/2013/03/lululemon-recalls-unintentionally-see-through-pants/

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