This Trend Could Continue As the Economy Reopens
Trade summary: A bull call spread in Lululemon Athletica Inc. (Nasdaq: LULU) using the July $320 call option which can be bought for about $17.50 and the July $330 call could be sold for about $13.40. This trade would cost $4.10 to open, or $410 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $4.10. The maximum gain is $590 per contract. That is a potential gain of about 143% based on the amount risked in the trade.
Now, let’s look at the details.
As the economy shut down and work from home increased, several trends emerged. One was the idea that comfort at work was positive and that led to increased sales of leisure clothing.
As the economy reopens, it appears likely the new office will be less used and some working from home will be a part of corporate life. This could benefit companies that make leisure clothing since there will still be a need for comfort at home at least once in a while.
LULU has been among the strongest performers in the recent rally.
That could explain recent news at The Street, about LULU. Two analysts raised their price targets for the athletic apparel maker.
Wells Fargo analyst Ike Boruchow “wrote in a report that the stock’s surge since mid-March means a more balanced risk/reward equation, given there’s still “plenty of risk in the consumer environment ahead,” Bloomberg reports.
That risk, of course, stems from the weak economy and the coronavirus pandemic. Lululemon stock has soared more than 120% since bottoming March 16. Lululemon, which went public in 2007, is trading close to a record high of more than $300.
The stock has shown “far and away the best performance” in Wells Fargo’s retail group, Boruchow said.
Despite the downgrade, Boruchow views Lulumon as a “high-quality best-in-class brand,” thanks to its strong digital operation, the buoyancy of the athletic apparel category and impressive liquidity and margins.
Boruchow raised his share-price target to $275 from $250, reflecting the stock’s recent jump. That raised price target is 11% less than Lululemon’s current share price.
Meanwhile, BofA Securities analyst Rafe Jadrosich lifted his target for Lululemon to $230 from $220 and affirmed his buy rating. Jadrosich’s raised price target is roughly 26% below the company’s current share price.
Morningstar analyst David Swartz also likes the company.
“While the COVID-19 crisis is a short-term impediment to its momentum, we believe Lululemon continues to benefit from a major fashion trend and will continue to achieve premium pricing due to the brand’s popularity and the styling and quality of its products,” he wrote in a commentary at the end of March.
“Our narrow-moat rating is based on Lululemon’s intangible brand asset.”
The longer-term chart shows that LULU is now resuming a multiyear uptrend after a potentially healthy pullback.
A Specific Trade for LULU
For LULU, the July 19 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A July 19 $320 call option can be bought for about $17.50 and the July 19 $330 call could be sold for about $13.40. This trade would cost $4.10 to open, or $410 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $410.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in LULU, the maximum gain is $5.90 ($330- $320= $10; 10- $4.10-5.90 = $5.90). This represents $590 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $410 to open this trade.
That is a potential gain of about 143% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying LULU could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.