Lululemon Athletica has helped investors express their financial namaste this year—and still presents opportunities even after nearly doubling in 2019.
Since we last recommended the stock around earnings about two weeks ago, shares have rallied $10, or about 5%, and our recommendation to sell Lululemon’s January $210 put for $4 has produced an even bigger return. The puts are trading around $1.18, representing a 71% return.
That trade captured a high level of implied volatility that was priced in to Lululemon’s options around its earnings report. Now, however, Lululemon’s options aren’t trading with much of a fear or greed premium at all, making them the perfect foil ahead of a key event that has historically moved the stock.
That event is the ICR Conference, an important meeting of retail companies and investors that runs from Jan. 13 to Jan. 15. Lululemon stock has moved about 7%, up or down, for the two days around ICR over the past eight years, according to Goldman Sachs. Lululemon stock has also moved 14%, up or down, during the first three weeks of January over the past eight years.
Yet January implied volatility for Lululemon is at 26%, the lowest level in history. The absence of an implied volatility premium almost certainly reflects the fact that earnings were just reported, and volatility naturally declines once the report is passed. It is almost certainly too low.
Goldman Sachs’ derivatives strategists are advising clients to “straddle” Lululemon’s stock to position for this important event that the options market seems to be ignoring. When the stock was around $223, Goldman told clients to buy the January $220 put and January $220 call for $14.23. The stock is now trading around $231 so anyone who like this construct—straddles win if the stock moves up or down for more than the cost of the options—can simply reset the strike prices with the January $230 puts and calls that cost about $14.
Of course, anyone who followed our recommendation to sell the January $210 put can simply enhance that position with a long call since investors still seem enticed by Lululemon even though the stock is up 90% this year.
These trades, and this stock, isn’t for everyone. Trading a stock that has surged so much, especially around spring-loaded key events, exposes themselves to significant risk—which is the defining fact of the trade.
Of course, the risk is defined by the cost of the options but that is of little solace if the stock moves in unexpected ways and money is lost on what seemed like a sound, reasonable opportunity.
Still, the Lululemon setup seems intriguing, the volatility profile is attractive, and the options market seems more focused on the holiday vacation than the trading calendar.
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December 24, 2019 at 11:00PM
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Lululemon Stock Could Make Big Move Around ICR Retail Conference. How to Play It. - Barron's
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