LULU Offers 14.16% Return For Contrarian Traders
Lululemon (LULU) has had a significant move up lately which has many investors asking if the rally is sustainable.
According to a recent article:
“… multiples have also shot through the roof, with shares now valued at a whopping 38.4x forward earnings - nearly 12 turns above peer NKE's valuation…. by no means do I see LULU as a bargain that I believe it was this time last year, when the stock traded at a very timid 20.8x forward earnings.”
Looking at the chart, we can see the massive spike higher following the positive earnings announcement. At this point, with the stock trading a whopping 60% above its 200 day moving average, it seems likely that LULU will need some time to digest it’s recent gains.
RSI is currently at a very high level and the last time we saw this in late 2017, the stock traded sideways for a number of months.
Traders who believe the LULU may not move too much higher over the next few months can achieve high returns via a bear call spread
One trading opportunity for those traders with this view is a bear call spread using the $150 strike as the short call and the $155 strike as the long call.
As of June 5th this trade offered a 14.16% return on risk over the next three months when using the September 21st expiry.
This trade has a 21% margin for error, so as long as LULU doesn’t rise another 21% in the next 3 months, the trade should work out.
Of course, it’s always a risky trade betting against such a strong stock and it is possible that traders could lose their full investment if LULU ends above $155 by September 21st.
The maximum profit on the trade would be $62 per contract with a maximum risk of $438. The spread would achieve the maximum 14.16% profit if LULU closes below $150 on Sept 21st in which case the entire spread would expire worthless allowing the premium seller to keep the $62 option premium.
The maximum loss would occur if LULU closes above $155 on Sept 21st which would see the premium seller lose $438 on the trade.
The breakeven point for the bear call spread is $150.62 which is calculated as $150 plus the $0.62 option premium per contract. Keep in mind that due to the bid-ask spread, you may not be able to get filled at these prices.
Traders not wanting to take a bearish exposure could always turn the trade into a neutral iron condor by selling the 105-100 put spread for $0.84.
Adding a put spread would bring in another $84 in option premium without adding any margin requirements to the trade.
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...
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