Even with a lackluster Holiday shopping season so far and less-than-stellar earnings reports in the retail sector from the likes of Macy’s (M), traders are looking at Lululemon Atheltica (LULU) with optimism.
Call buyers think the company will head higher following tomorrow morning’s earnings report. Analysts are expecting earnings of 37 cents per share on revenues of $482 million.
LULU stock rallied sharply into the close yesterday following some large call buying, with 36,455 calls traded yesterday — nearly four times the average daily volume of 9,653. Notably, 5,262 of the Dec 11 $55 calls (which expire this Friday) traded, with an implied volatility (IV) of 105. The 30-day IV of $59.97 is still in the 90.08 percentile, just off the 52-week high of $63.79.
LULU Stock Chart
LULU stock broke past the important 50-day moving average at $50.36, closing just off the high of the day at $51.79. The next level of resistance in LULU stock is $52.70, with a lot of blue sky on the chart if Lululemon stock can move past that area. Takeover chatter, so far unfounded, also surrounds Lululemon stock, with Nike (NKE) and Under Armor (UA) bantered about as potential suitors.
Term structure of volatility, which compares the implied volatility of different option expirations, is extremely steep in front of earnings, with front week IV levels of 115 nearly double the end-of-year IV of 58. Such steep levels are an indication of heightened fear in the options market, normally a reliable contrarian bullish indicator.
This sets up a spread opportunity that looks to position bullishly along with the big call buyers while capturing the rich, short-term option premium in a defined risk manner. The trade structure is a calendar spread, buying the LULU Jan $55 calls at $2.65 (57.62 IV) while selling the LULU Dec 11 $55 calls at $1.30 (105.34 IV).
The maximum loss is the net premium paid of $1.35, with the maximum gain realized if LULU stock closes near $55 on expiration this Friday. If LULU is below $55, additional short-term calls can be sold against the long Jan $55 calls to further hedge the position.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
