Credit: Shutterstock photoJim Cramer doesn't look like a Namaste kind of guy, but who knows what his hobbies are in his personal time. We do know, thanks to his spirited rants on Mad Money, that he's a fan of upscale yoga gear purveyor Lululemon (NASDAQ:LULU).
Cramer flagged this name as one of four "junior growth stocks" earlier this week and said it "can be [a] winner." This outlook has certainly been true of late. Last week, the company forecast fourth-quarter profit of 46 cents per share or better, topping analysts' consensus view by a nickel. On this news, the stock spiked to a new all-time high.
The stock has rocketed up more than 45% in the last month and is nearly 130% higher year-to-date. The bullish camp might argue that "the trend is your friend" and LULU will continue to rally until a fundamental change warrants a reversal. The skeptics might be wary of a stock that has run so far, so fast.
Regardless of your thesis in LULU, it may make sense to explore some strategic options-trading alternatives. Options strategies can help you hedge your portfolio and may be able to enhance your returns if properly executed and managed.
As examples of potential option strategies to consider, we have outlined two strategies below – a long call and a married put, which are the foundations of most option strategies we discuss in the blog. These write-ups are educational and should not be regarded as buy or sell recommendations. All prices are as of Thursday midday, when LULU shares were trading at $69.66, up $1.02.
Bullish Option Strategy: Stock Replacement Strategy (Long Call)
Investors who expect LULU to continue moving higher for the next few months could buy a long call in lieu of buying the shares outright. The March 60 call, for example, carries nearly $10 in intrinsic value (i.e., the amount by which the call is in-the-money) and can be bought for $12 per contract ($1,200 per lot). This compares to the $7,000 price tag needed to purchase 100 shares of LULU.
Delta for this call at the time of purchase is roughly 80, so the call will gain/lose 80 cents in value for every $1 increase/decrease in the stock itself. Delta is a fluid number that changes daily with movement in the stock, deterioration of time, and changes in volatility. For example, if the stock were to quickly shoot up to $73 in the next five days, delta would rise to 85.6 as the call gains in intrinsic value but loses a modest amount of time value.
At expiration, gains are theoretically unlimited for the call holder if LULU is trading above the breakeven price of $72 (the 60 strike plus the premium paid). Losses are capped at $12 if LULU is trading at or below $60. Between $60 and $72, the investor will be able to take back at least part of the premium paid.
The chart below was built with a profit/loss calculator, which lets you change inputs such as days until expiration and volatility changes. Open a virtual trading account to explore this and other tools such as the probability calculator and volatility charts.
Hedged Option Strategy: Long Stock with Married Put
Long stock holders who fear LULU may lose some steam might consider a long put hedge. The March 65 puts are currently priced at $4.40 per contract.
Delta for this out-of-the-money put is currently -25, so the put will gain a quarter for every dollar LULA declines (and lose a quarter for every dollar LULU gains). Puts have negative delta while calls have positive delta. “Marrying" this put to a long stock position would still give long exposure overall. Stock has a 100 delta so the combined delta would be positive 75. However, if the stock falls, the put holder has the right to sell his long shares at 65, mitigating any further downside.
If the stock is trading above the 65 strike at expiration, losses are capped at 100% of the premium paid for the put, or $4.40. If the stock gains more than this amount, the overall strategy will be profitable. Breakeven, therefore, is $74.06, or the current stock price of $69.66 plus the $4.40 premium paid for the long put. Below 65, losses are limited to the put premium plus the losses in the stock from $69.66 down to 65 (a total loss of $9.06).
It is interesting to note the PNL graph at expiration is identical shape to that of the straight long call. For this reason, the long stock long married put strategy is sometimes referred to as a synthetic call.
Please refer toCharacteristics and Risks of Standardized Options, copies of which can also be obtained by contacting our Customer Service Department atcustomerservice@optionshouse.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
