Sometimes looks can be deceiving — that applies in a lot of places, and trading is one of them. For instance, great fundamental companies sometimes have terribly performing stocks, and less-than-desirable companies can watch their stock hit the roof.
Here is a trade idea on Lululemon (LULU) that is partially based on that notion.
Lululemon Athletica (LULU — $58.02): Call Credit Spread
The trade: Sell the LULU Jan 60/62.5 Call Credit Spread (selling the Jan 60 call and buying the January 62.5 call) for 50 cents or better.
The strategy: The maximum potential profit for this trade is 50 cents if LULU stock is trading below $60 at January expiration. Both call options would expire worthless. The maximum loss is $2 ($2.50 – $0.50) if LULU is trading above $62.50 at January expiration. Breakeven is $60.50 at expiration based on a credit of 50 cents.
The rationale: Quite a few nice things have been written about Lululemon lately. Even one of its sister companies, Ivivva Athletica, is doing fantastic after posting a 17% comparable-store sales growth for the third quarter. Several analysts have commented that they are optimistic about the long-term growth potential of LULU. One analyst even raised his price target to $73 and upgraded the stock to “buy” from “neutral.” With all this bullish talk, Lululemon stock must be moving higher right?
Well, not exactly … and that is why this trade idea might be appealing.
Click to Enlarge LULU stock slid and closed under $60 on Dec. 13 and has not been able to close above that mark since. Even with all this recent positive talk, Lululemon has tried to move higher but succumbed to a close lower than the open the previous few sessions. There is no doubt that LULU stock might eventually move higher, but this credit spread expires in less than two weeks.
What is making this trade idea interesting is the implied volatility of the options. A retail sales report is scheduled for next week, and the IV of the options is elevated in front of this report. After the report, the IV might drop some — if so, option premiums should follow, which would help a credit spread. If the report sheds a negative light on holiday sales, it also could send retail stocks like LULU lower, too.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities. Get a free trial of John’s live options trading room here.