Ulta Beauty Inc (NASDAQ:ULTA) was once viewed as a stock immune to the Amazon.com, Inc. (NASDAQ:AMZN) effect. What ULTA stock bulls didn’t account for was brewing internal weakness in the sector. The selfie generation must have had a bout of cost consciousness but one that is not likely to last long.
ULTA is a prior shooting star that has fallen out of favor. I don’t want to be a follower; I trade it based on my own analysis. Today, I want to set another bullish trade on ULTA stock, but without the hope of a massive rally. I will use options where I can sell downside risk against proven support and let time do the rest.
The Right Move With ULTA Stock
The stock recently survived a brutal beating. It fell 40% since June, but it found footing in the last few weeks and therein lies my opportunity. When a quality stock like ULTA Salon gets punished, the upside of that is that we learn of where strong support lies. In this case, we saw the bears get the upper hand on several trendlines, until the bulls held at the $200-per-share mark.
Fundamentally, UTLA is not bloated. It sells at a 28 price-to-earnings ratio. This is half of that of e.l.f. Beauty Inc (NYSE:ELF). It’s even cheaper than Estee Lauder Companies Inc (NYSE:EL). With a decent valuation, I am comfortable selling puts below support. The worst case scenario for me would be ULTA to fall past my support, forcing me to own shares at a heavy discount from here. Not such a terrible outcome even then.
Technically, once ULTA lost the $240 zone, $200 was a mere formality. In fact it’s not yet in the clear. The breach of $210-per-share could have targeted $180 or lower. But so far, that neckline target has not come to fruition. This is in spite of the general market malaise from last week. So the test was legitimate therefore the support is proven. So, as long as the macro thesis remains bullish, ULTA should hold.
Management reports earnings soon so any trade I set today will have to survive the short-term reaction of Wall Street. Those on earnings events are completely binary and almost independent of the quality of the report. Case in point, you can review how traders first rallied on the beautiful quarter from Applied Materials, Inc. (NASDAQ:AMAT) then closed red on the day. Now it’s finally back to green.
Traders often get confused on the event itself, but eventually fundamentals will win out.
The Bet: Sell the ULTA Jan 2018 $175 naked put for $2.25. This is a bullish trade, where I have a 85% theoretical chance for maximum gains. Otherwise, I will own shares and accrue losses below $172.75.
Selling naked puts comes with big risk, especially for a retail stock like ULTA. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell the ULTA Jan 2018 $175/$170 credit put spread, which would deliver over 15% in yield, but with much smaller risk. Both set ups have about the same odds of success and neither require a rally to win.
Today’s trade, although it would benefit from one, doesn’t need a rally to profit. I simply need ULTA stock to hold its support through mid January. I am betting that the value in the stock will prevent sellers from taking too far.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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 as @racernic on twitter.