Yoga Pants Are Popular WFH Clothes, and a Potential Triple Digit Trade
Trade summary: A bull call spread in Lululemon Athletica Inc. (Nasdaq: LULU) using the June $270 call option which can be bought for about $14.57 and the June $280 call could be sold for about $9.92. This trade would cost $4.65 to open, or $465 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 $4.65. The maximum gain is $535 per contract. That is a potential gain of about 115% based on the amount risked in the trade.
Now, let’s look at the details.
LULU is a specialty retailer. The company is best known for a its athletic apparel. It offers a range of apparel and accessories for women, men and female youth.
The company’s apparel assortment includes items, such as pants, shorts, tops, and jackets designed for healthy lifestyle and athletic activities, such as yoga, running, training, most other sweaty pursuits. It’s products are also popular as weekend wear and for working from home.
LULU is likely to be among the winners as WFH becomes more popular even after the economy reopens. As Barron’s recently noted, B. Riley analyst Susan Anderson is upbeat on specialty retailers in general and on LULU in particular.
“She reiterated a Buy rating and $290 price target on LULU.
While the company is clearing out inventory via promotions online, she notes that the company will likely “fare better than most retailers, due to their premium brand strength, consumer transition to fitness as they stay at home, and high-quality offerings.”
Lululemon is also offering free online workouts, which should engage consumers and help drive and maintain loyalty among its base.
Lululemon is up nearly 10% year to date, a time that has seen plenty of pain elsewhere in the market and in retail specifically. With remote work likely to continue for some time, its focus on athleisure is a major advantage, and many think it could continue to be winner in the new normal.”
The stock has recovered from the panic selling seen earlier this year.
The longer-term chart using weekly data is bullish as the stock appears well positioned to resume its up trend.
LULU had been in a strong uptrend before the broad market sell off and is among the first stocks to retrace all of its losses.
That pattern — an uptrend, a retracement and a recovery – is potentially bullish. Combined with the strong fundamental demand for its products, the bullish technicals point to likely gains in LULU.
A Specific Trade for LULU
For LULU, the June 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 June 19 $270 call option can be bought for about $14.57 and the June 19 $280 call could be sold for about $9.92. This trade would cost $4.65 to open, or $465 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 $465.
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 $5.35 ($280- $270= $10; 10- $4.65 = $5.35). This represents $535 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $465 to open this trade.
That is a potential gain of about 115% 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.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.