LULU Earnings Play

Unlike LULU’s pants, apparently their earnings are harder to see through.

On 6/11/2014 I opened a trade on LULU. LULU was set to announce earnings after the close of the market on the 12th.

At the time, LULU was trading around 44.30 and had a high implied volatility leading up to earnings. I was anticipating decent earnings and hoping for the stock to go up (or only down slightly) and for the volatility to get crushed after the earnings announcements were factored in. My thought was that I could then buy the put back for a lot less.

Since I am not yet tier 3 on TD Ameritrade, I could not sell the naked put on margin so I did this trade as a cash-secured put.

Trade Details:
Type: cash-secured short put

06/11/14 STO 1 LULU Jun21 2014 40 Put @ 0.68
Comm = 1.54
Credit: $0.68

This trade could turn out a few ways:

Max Profit $68 – $1.54 = $66.46 Max profit occurs if LULU is greater than 40 on expiration day, which is June 20. Max Profit = Net Premium Received – Commissions Paid
Max Loss $4000 + $1.54 – $66.46 = $3935.08 Max loss occurs if LULU goes bankrupt before expiration day, which is June 20. Max loss = stock drops to $0
Breakeven Point $0 Breakeven point occurs at 39.32. Breakeven Point = Strike Price of Short Put – Net Premium Received
Possibly Assigned Shares varies At any point when the stock is trading for less than 40 I could be assigned 100 shares at $40/share.

Earnings wasn’t as good as the market was hoping and LULU took a huge dive (around 17%), meaning that my put is now in-the-money. At this point I could be assigned the 100 shares and, at Friday’s closing price of 37.61, I would be immediately down $171 (39.32-37.61).

If I had “bought insurance” by choosing to do a vertical credit spread instead of just the short put, I would have less ways of fixing this. There’s four things that could happen now.

1) I could choose to take the loss and buy the put back. I don’t really want to do this because I’d “lock in” the loss,

2) I could be assigned the shares. In doing so my breakeven point would be $39.32. Since I have that credit, it doesn’t have to get all the way back up to $40. I’d then start selling covered calls, lowering my cost basis each time and hopefully lowering it enough so that when it gets called away or sold on the open market, I’d have made some money,

3) LULU rallies back above $40. The option expires on June 20th so there’s still a few days left for that to happen. I’d then just let the option expire worthless and get to keep the entire $68 credit,

or 4) I could choose to roll to a later expiration and/or a different strike price.

Update (6/19/2014): A couple of good things happened. #1 I’m no longer in-the-money on my short option as the stock is back up above 40. And, #2 I was able to roll the trade out an additional week for some credits.

Here’s what I did:
06/16/14 BTC 1 LULU Jun 21 2014 40 Put @ 2.54
06/16/14 STO 1 LULU Jul 3 2014 40 Put @ 2.82
Comm = 3.07
Credit: $0.28

06/18/14 BTC 1 LULU Jul 3 2014 40 Put @ 1.36
06/18/14 STO 1 LULU Jul 19 2014 40 Put @ 1.76
Comm = 3.07
Credit: $0.40

I’ve so far collected $1.36 in credits, bringing my breakeven point down to $38.64.

07/03/14 BTC 1 LUL Jul19 2014 40 Put @ 0.30
Comm = 1.54
Debit: $0.30

On 7/3/2014, I saw that LULU had shot higher (with the market as a whole). I bought-to-close the put option for a debit of $30; I could probably have held on to expiration and let the option expire. However, I’ve been learning to manage winners so decided to take profits while I had them. Additionally, had the earnings play initially gone in the correct direction, I would have definitely closed the put for this debit, since it is greater than a 50% winner from the original $68 credit I received. But now, because I’ve rolled the option a few times, my total profit on this trade is $106 before commissions.

With a few rolls I’ve managed to turn an initial loser, in which the stock went in the complete opposite direction from my assumption, into a $106 gain in less than 3 weeks!

Profit (after commissions): $96.78

You may also like...

Leave a Reply

Your email address will not be published. Required fields are marked *

CommentLuv badge

This site uses Akismet to reduce spam. Learn how your comment data is processed.