We all know the brick-and-mortar retailer woes. Their stocks have been decimated, and experts blame Amazon.com Inc (NASDAQ:AMZN) for the carnage. A high-profile example of this isMacy’s Inc (NYSE:M), which has fallen more than 50% since last November. There have been exceptions, and Ulta Beauty Inc (NASDAQ:ULTA) is a great one.
Unfortunately, summer has not been good for ULTA stock, which has fallen 25% since June. Luckily, this came after a 35% rally off the 2016 U.S. elections, and after a more than tripling over the past few years.
Currently Ulta shares hover just above an important level from which the November rally started.
The $225 area is one of contention. Bulls and bears will want to fight over it tooth and nail. In May 2016, the bulls rallied through it behind a strong earnings report. They then used it as the base for a mega-rally which just ended. Now they are approaching it again. So unless the macroeconomic picture changes, I am confident that the $225 area will continue to lend support.
Today, I will share a bullish bet on this dip in ULTA stock. I won’t buy the shares outright, but instead will use options to better place my risk with room for error. A falling knife in retail is scary enough to catch. Ulta, which has a three-digit price tag, is exceptionally frightening.
Therein lies opportunity to sell downside risk against fears to generate profits with no out-of-pocket expense.
I have my worries. Even Ulta’s biggest fan has softened his stance on the bullishness of the stock. CNBC’s Jim Cramer, who usually pounds the table to buy the stock on every dip, recently acknowledged evidence of softness in the beauty sector.
I doubt the selfie generation suddenly cares less about how they look than just a few weeks ago. Thus, this malaise in ULTA stock shall pass. A correction after a strong rally does not necessarily mark the end of Ulta’s term as a leadership stock.
Ulta Beauty also is fundamentally not cheap. It has a trailing price-to-earnings ratio of 32 and net margins under 9%. It’s hard to find a comparable retailer to gauge its real relative value, though, so I continue to judge it against its own price performance.
I have no reason to believe yet that Ulta will fail to deliver on its targets, and I assume its Q2 earnings report, due out tonight, will prove me right. So right now, I am comfortable owning the stock if it falls much deeper below these levels.
How to Trade ULTA Stock
The Bet: Sell the Jan 2018 $175 naked put for $3.70. This trade has 85% theoretical odds that prices stays above the sold strike price. Otherwise, I will be forced to buy shares and could suffer losses below $171.30.
Those who prefer to limit the risk can sell put spreads instead. To do that, I buy an equal number of puts below those that I sell.
The Alternate Trade: Sell the Jan 2018 $175/$170 credit put spread. If successful, this trade would deliver 20% in yield.
Both trades allow for a large margin of error. Neither setup requires a rally to profit. ULTA stock can fall 24% and I can still accomplish maximum gains.
Investing in the stock market doesn’t come with guaranteed results, however, so never risk more than you can afford to lose.
Learn how to generate income from options here. 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. You can follow him on Twitter at @racernic and stocktwits at @racernic.
