A Sneaker Maker Makes Big Moves, Again
Some stocks are consistently volatile. These can be the kind of stocks a trader keeps on their radar. That could involve setting a news alert to be notified of important events that effect the stock. Or, it could involve simply glancing at a chart of the stock every few days.
Under Armour, Inc. (NYSE: UAA) is one of those consistently volatile companies. The stock has started the year with volatility, and that could lead to a trading strategy.
In the first few days of 2018, UAA rallied more than 11%. This could be a “reverse window dressing trade.”
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Window dressing is believed to be practiced by investment managers at the end of the quarter. They buy shares of top performers so they can include positions on their quarterly reports to investors. This is similar to a department store putting their best merchandise in windows and carries the name, window dressing.
Reverse window dressing shows what large managers really think about a stock. They may not want to hold the position on the last day of the quarter because they are concerned their investors will not be impressed. This could be true of stocks in down trends like Under Armour.
But, after the quarter ends, like it did in the first days of January, they buy in order to gain exposure to a stock they believe in. The sharp rally in UAA could have led to short term profit taking by the early buyers. After all, a 10% gain in less than a week is hard to resist.
What’s Next for Under Armour
Now, investors who own Under Armour face longer term decisions. Here, the outlook is uncertain.
Analysts at CFRA are bearish and assigned a rare sell rating to the stock. Overall, we generally expect less than 10% of stocks to carry sell ratings from major research firms. CFRA analyst Victor Ahluwalia reiterated his $11 price target based on Under Armour’s discounted cash flow.
That price is well below the current price and, in fact, he sees the stock losing almost a third of its value over the next 12 months.
Ahluwalia lifted his 2017 earnings per share (EPS) estimate by $0.01 to $0.20, while cutting his 2018 EPS estimate by $0.02.
“UAA stock has moved back to pre-Q3 earnings levels since we changed our previous rating to a hold from a sell. There has been no meaningful change in fundamentals except benefits from the tax reform that are reflected in our updated estimates,” according to CFRA.
“We expect further dismal sales performance in Q4 and note that UAA was the most promotional among peers during the 2017 holiday season,” the analyst concluded.
Analysts at Susquehanna agree with this assessment. They began a research report released on Tuesday with a stark and clear assessment of the company: “Sell UAA.” The company, they wrote, is suffering from a brand that “will continue to weaken before it is clear if it can be salvaged.”
To do so, they wrote, Under Armour needs to reclaim its place as an “aspirational” brand in part by pulling merchandise from retailers that don’t position it that way. “Those better retailers planned the Under Armour business down double digits in 2017 and will continue to do so in 2018,” according to Susquehanna.
While the outlook may be bearish, the stock is likely to remain in a relatively narrow trading range for a few weeks as investors await news from the company. Under Armour is expected to release earnings on January 30 and the stock has a tendency to make a large move after the news is released.
Trading the Time Until Earnings
When a stock is expected to trade in a narrow range, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.
Among those strategies is a bull put spread. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up trend.
Source: The Options Industry Council
This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.
Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.
Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.
For UAA, a bull put spread could be opened with the January 19 put options. This trade can be opened by selling the January 19 $15 put option for about $0.30 and buying the January 19 $14.50 put for about $0.10.
This trade would result in a credit of $0.20, or $20 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.
The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $0.50 ($15 – $14.50). This is multiplied by 100 since each contract covers 100 shares.
Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $30 ($50 – $20).
The potential gain is about 60% of the amount of capital risked. This trade will be for about one week and the annualized rate of return provides a significant gain.
The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.