Lululemon (LULU) is set to report earnings on March 21st and the market is pricing in a 10.1% move in either direction.
LULU stock is rated a 56% Buy according to the Barchart Technical Opinion with a weakening short term outlook on maintaining the current direction.
The following trade will do well if the stock stays below $540 between now and March 21st.
The strategy is called a diagonal call spread and it’s an advanced strategy because it utilizes options over different expiration periods and different strike prices.
The strategy involves selling an out-of-the-money call for a near term expiry and then buying a call for around the same price using a later expiry.
The idea with the trade is that the stock might rally a little but should stay below the short strike price.
Let’s look at an example using Lululemon.
Lululemon Diagonal Call Spread Example
The trade I’m looking at is selling a March 22 call with a strike price of $540 and buying an April 5 call with a strike price of $550.
The March 22 call could be sold for around $4.00 and the April 5 call could be bought for $4.75.
The trade would result in a net debit of $75.
The risk on the trade is on the upside with a potential maximum loss of $1,075. This is calculated by taking the difference in the spread (10) multiplied by 100 and adding the premium paid (75).
The maximum potential gain is around $2,000 which would occur if LULU closes right at $540 on March 22.
The trade has a nice profit zone in between $450 and $590.
Aiming for a return of around 5-12% makes sense and I would set a similar stop loss.
The worst-case scenario is a sharp rise in LULU stock early in the trade. For this reason, if the stock rises above 530 in the next few days, I would also consider closing the trade early to minimize losses.
The initial trade set up has a delta of 0 meaning the position is roughly delta neutral to start. Note that this delta number can change significantly as the stock starts to move.
Below is the payoff graph with the blue line representing the profit or loss at expiration and the purple line being the trade as of today.
This is how the trade could look in around five days’ time.
So, provided LULU stock stays below 580 in the five days, the trade should be ok. As the trade requires the stock to not rise too much, this would not be an appropriate strategy for bullish traders.
Lululemon Company Details
lululemon athletica inc. designs, manufactures and distributes athletic apparel and accessories for women, men and female youth.
The company offers a line of apparel assortment, including fitness pants, shorts, tops and jackets designed for healthy lifestyle and athletic pursuits, such as yoga, training, and running as well as other sweaty and general fitness under the lululemon athletica brand name.
Its fitness-related items comprise an array of accessories like bags, socks, underwear, yoga mats, instructional yoga DVDs, water bottles and other equipment.
The company sells its products primarily in North America through a chain of corporate-owned and retail stores, outlets and warehouse sales, independent franchises, and a network of wholesale accounts. The company has an e-commerce site with an aim to rapidly expand its online business.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
