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Skip Raschke Options Trade: LULU

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Stocks in this article: LULU

Lululemon Athletica (LULU) has been in the athletic apparel business since 1998. The company specializes in premium workout apparel, especially for those who can bend their torso well enough in those clothes in order to do yoga. LULU trades at a rather high P/E of 41X trailing earnings and 30X forward, or projected, earnings. A high P/E always raises the risk factor.

Technically, LULU has moved up rather nicely since making a bottom around $62 in the first week of April. LULU then formed into my coiling pattern around $67, moving up about 10% over the next few weeks. I now have LULU entering overbought territory. Those traders who were short LULU were squeezed during this move no doubt, but I think these shorts will eventually be right. The slow stochastic is now at its zenith while the RSI is declining. That is not a positive technical combination for any stock.

Eventually all stocks trade at their fundamental value. Stocks that trade at a high P/E ratio must continue to grow their earnings quarter after quarter at a rate close to what the forward P/E ratio implies is the growth rate. Do not keep up growth and eventually the stock will begin to discount the fact that it is not growing near the market's expectations. Time that event and the short sellers win that next round. For the next few quarters LULU could report flat to negative earnings.

The trade tactic I like for LULU is a deep in-the-money call time spread. This tactic profits should the stock drop in price yet is set up to possibly become a naked long call if the timing of the spread's expiries are calibrated well enough relative to the future price action of the stock. In addition the risk is 100% controlled.

LULU does not currently pay any dividends, which tends to negate the possibility of an early exercise of the short call. However that potential is always in play! Thus the potential for an early exercise is a risk regardless if the percentage of its potential is very low. Bear this in mind while considering the trade set up.

Trades: Sell to open 3 LULU December 60 strike at $17.00 and buy to open 3 LULU January 60 strike calls for $17.40.

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