In the past 12 months, Under Armour Inc (UA) has seen great rallies and neck-breaking drops. Recently, it had been riding a 23% rally off the 2016 lows.
On April 11, Under Armour was downgraded by Morgan Stanley, causing an up to 7% drop over two days.
Fundamentally, there is no doubt that UA management is perceived to be adept at securing the right strategic endorsements of key celebrity athletes.
Technically, the UA stock price now rests on a recent pivot point. Unfortunately for UA bulls, the current price is not a clear bounce level but rather a teeter. The momentum from here could easily carry it another five percent lower.
UA Stock Trade
I would like to set up a short trade disguised as a cautious bullish trade on UA stock. I am not brave enough to sell the stock outright here, as this would carry unlimited risk. I like defined risk where I can leave room for error. Therefore I will resort to the options markets, where I have hundreds of ways I can accomplish my goals.
Trade No. 1: Since there is a real possibility that Under Armour is not done falling, I want to capture the incremental downside move. So, I buy UA May $40 put. For this I pay $1.73 cents per contract. Should UA drop precipitously in the next forty days, I stand to gain from put price appreciation. My break-even point is UA $38.27.
To lower my risk exposure, I want to reduce my out-of-pocket expense.
Trade No. 2: I sell the Jan 2017 $30 put. For this I collect $1.45 per contract. Selling naked puts is somewhat risky, and I only do it when I am willing and able to buy UA stock at the put strike.
These trades, when taken together, result in a net out-of-pocket expense of only 28 cents per contract. This is a small cost to be short Under Armour stock close to the money. Ideally, I need UA stock to approach $30 per share in May, then rebound. I would then sell my May puts for a profit. The Jan sold puts would expire worthless for maximum gains.
If it becomes evident that traders are stepping long into UA stock and that a clear bottom is forming, I would then sell my May puts, leaving me long under Armour. Profit would then come from the premium I collected from trade No. 2 as long as Under Armour closes above $30 per share mid Jan 2017.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
