The retail trade is back en vogue on Wall Street. Stocks like Amazon (NASDAQ:AMZN) and Lululemon (NASDAQ:LULU) are up 70% year-to-date. The SPDR S&P Retail ETF (NYSEARCA:XRT) is up 12% for the same period. I remember times when retail was depressed because of Amazon’s success.
Last night, Ulta Beauty (NASDAQ:ULTA) reported earnings and ULTA stock was down big on the headline. The knee-jerk reaction to the headline was even worse as it hit $223. Today, ULTA is in recovery mode — currently up 7% — but an appealing opportunity still exists.
Today, I suggest diving into this stock, but with caution. I will not buy ULTA shares without any protection. Instead, I suggest options, where I can generate income without any out-of-pocket risk.
The knee-jerk reaction flash dip gave me a range of prices. Today, I sell downside risk against proven support and profit from what others fear. ULTA stock is testing a band of well-consolidated price ranges that will hold as support for 2018.
Fundamentally, ULTA is not bloated with a 22 price-to-earnings ratio, but it’s not a screaming bargain. So there is room to further punish the stock. Management did beat on earnings, but the guidance was soft. Furthermore the comparable sales were soft. This happened at the same time that LULU delivered an impressive earnings report.
Click here for a five minute video describing the opportunity and risk in ULTA stock. It shows how options offer a cautious way to catch a falling knife while leaving room for error. This is especially important while markets are at all time highs.
Technically, Coming into the earnings event Ulta was lagging the XRT. It also has proven support from a two-year-old pivot zone above $210-per-share. It would take a market-wide correction to cause a dip below it. Meaning that even though this earnings report was not exciting, it doesn’t foretell a looming disaster either.
The worst case scenario of my trade today is that I own shares of LULU at a 15% discount from the current price. Should that happen, I am confident that I will manage out of them for gains in the long run.
Ulta’s team is still growing transaction sales and average ticket prices. So they know how to drive traffic and how to up-sell. Wall Street experts agree, as it is still trading well below their average price target.
How to Trade ULTA Stock Today
The Trade: Sell the ULTA Dec $205 naked put for $2. This is a bullish trade where I have a 90% theoretical chance for maximum gains. Otherwise, I will own shares and accrue losses below $203.
Selling naked puts is daunting especially near all time high stock markets. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell the ULTA OCT $200/$205 bull put spread, which has about the same odds of winning and would yield 12% on risk. Compare this with risking $263-per-share without any room for error except a rally profit.
It is important to note that today’s trade doesn’t need a rally to profit. I simply need support for ULTA stock to hold for the near-term. Time will then do the heavy lifting and erode premiums to expire in my favor.
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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 and stocktwits.
