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One Lululemon Athletica inc. (LULU) Bull Eyes a Long-Term Recovery

Lululemon Athletica inc. options traders pounce as stock touches new low

by 1/14/2014 11:09 AM
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Lululemon Athletica inc. (NASDAQ:LULU) shares went on a wild ride in Monday's session, gapping lower at the open and reaching a two-year low after the yoga apparel name reduced its fourth-quarter outlook. Options players responded enthusiastically, boosting both call and put volume to quadruple average daily levels. By the end of the day, the shares had logged a 16.6% drop, and roughly 77,000 calls and 59,000 puts had changed hands.

Among the most active strikes -- and the two strikes seeing the largest increase in open interest this morning -- were the January 2015 52.50- and 72.50-strike calls. Nearly symmetrical blocks of roughly 7,500 contracts traded within minutes of each other, suggesting the action was related. The 52.50 calls went off at the ask price of $6.45 per contract, while the 72.50 calls traded at the bid price of $1.70 apiece. It looks as though one trader executed a long call spread in hopes of a longer-term recovery.

The most the spread buyer can lose -- if LULU is trading south of the long strike price ($52.50) at expiration in a little over a year -- is 100% of the premium paid, or $4.75 per pair of contracts. (This amounts to roughly $3.5 million, when accounting for the total volume.) The maximum potential gain, meanwhile, is $15.25, or the difference in strike prices less the net premium paid. This would be achieved if LULU is trading at or above $72.50. A move of this magnitude is certainly not out of the question; Lululemon shares were sitting above this level as recently as October. Finally, breakeven on this strategy, at expiration, is $57.25, or the long strike plus the net debit.

Profit loss chart of Lululemon long call spread

Not surprisingly, LULU has been a favorite among short sellers of late. Nearly 16% of the stock's available float has been sold short, amounting to a short-interest ratio of 6.9 days to cover. It's therefore possible that yesterday's call spread buyer was a large-scale short seller setting up a hedge (although the lengthy time frame would be rather atypical).

As noted, Lululemon Athletica inc. (NASDAQ:LULU) tumbled yesterday after reducing its revenue and earnings forecast for the fiscal fourth quarter, which ends on Feb. 2. Wall Street responded with a number of downgrades, which have continued into today's session. LULU shares touched their lowest point since January 2012 today, at $48.89, and are currently hovering around $49.34.


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