Investors have slightly bid down the share prices of Lululemon Athletica Inc. (LULU) ahead of the company's fiscal second quarter earnings announcement. At first glance, it appears that option traders are positioned for a negative move, as there are a growing number of put options in the open interest. The unusual option activity could create a strong downward trend in the price action if Lululemon delivers a negative earnings surprise.

The open interest for LULU shows an increasing number of put options, and option premiums are unusually high right now. Trading volumes indicate that traders have been buying puts and selling calls in anticipation of a negative earnings report. Unwinding these bets could place unexpected upward pressure on the share price of LULU.

It is challenging to accurately predict the direction a stock will move after earnings. However, a comparison between the stock's price action and option activity shows that, if LULU delivers a positive report, the company's share price could rise, moving above its 20-day moving average after the announcement. This could happen because options are priced for a downward move, but unforeseen good news could catch traders off guard and create a swift rise in share price.

Key Takeaways

  • Traders and investors have slightly bid down the share price ahead of the earnings report.
  • The share price has recently been closing below its 20-day moving average.
  • Call and put pricing is predicting a stronger move to the downside.
  • The volatility-based support and resistance levels allow for a stronger move to the upside.
  • This setup creates an opportunity for traders to profit from an unexpected earnings result.

A comparison between the details of both stock price and option behavior can grant chart watchers valuable insight. However, it is necessary to understand the context in which this price behavior took place. The chart below depicts the price action for the LULU share price as of Sept. 7. This created the setup leading into the earnings report.

Earnings pricing for Lululemon Athletica (LULU)

Current Trends

Over the past month, the trend for LULU stock has the share price rising above then falling below its 20-day moving average. In this time period, it's notable that the highest LULU share price was roughly $418 in late August, whereas the lowest share price was $385 only several days prior. The price closed in the middle region depicted by the technical studies in this chart. 

The studies are formed by 20-day Keltner Channel indicators. These depict price levels that represent a multiple of the Average True Range (ATR) for the stock. This array helps to highlight the way the price has fallen below the 20-day moving average in the week before earnings. This price move from LULU shares implies that investors' confidence is waning as the earnings report approaches.

Tip

The Average True Range (ATR) has become a standard tool for depicting historical volatility over time. The typical average length of time used in its calculation is 10 to 20 time periods, which includes two to four weeks of trading on a daily chart.

In this context where the price trend for LULU has closed below its 20-day moving average, chart watchers can recognize that traders and investors are expressing growing pessimism going into earnings. It's notable that, in the week before earnings, LULU's share price is close to breaking support to the downside. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for favorable earnings or not.

Option trading details can provide chart watchers with additional context to help them form an opinion about investor expectations. Recently, option traders are favoring puts over calls by a narrow margin. On Tuesday, there were over 11,000 calls traded opposed to over 14,000 puts. Normally, this volume indicates that traders are feeling bearish toward the earnings report.

Tip

The Keltner Channel indicator displays a set of semi-parallel lines based on a 20-day simple moving average and an upper and lower line. Because the upper lines are drawn by adding a multiple of ATR to the average and the lower lines are drawn by subtracting a multiple of ATR from the average price, then this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that LULU shares are in a below average range and have priced their options as a bet that the stock will close within one of the two boxes depicted in the chart between today and Sept. 10, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 37% probability that LULU shares will close inside this range by the end of the week if prices go higher. The red box represents the pricing for put options with a 33% chance if prices go lower on the announcement. 

It is necessary to note that the open interest featured over 43,000 calls to over 56,000 puts, demonstrating the bias that option traders had, as traders favored puts over calls. The implied volatility for the higher volume of puts has been rising, indicating that traders are buying these options. This reflects a bearish sentiment around LULU earnings. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of purchased put options has only mildly skewed expectations lower. A far more complacent outlook is implied.

Option pricing for Lululemon Athletica (LULU)

The purple lines on the chart are generated by a 10-day Keltner Channel study set at 4 times the ATR. This measure tends to create highly correlated regions of strong support and resistance in the price action. These regions show up when the channel lines make a noticeable turn within the previous three months. 

The levels that the turns mark are annotated in the chart below. What is notable in this chart is that the call and put pricing are in such a close range with plenty of space to run either way, but with more room to the upside. This suggests that option buyers don't have a strong conviction about how the company will report, even though recent put volumes outweigh call volume. Although investors and option traders do not expect it, a surprising report could push prices dramatically higher or lower.

Volatility pattern for Lululemon Athletica (LULU)

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that any news, surprisingly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, LULU shares rose 3.8% the day after earnings, before rising the following week. Investors may be expecting a dissimilar move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

Retail apparel companies have had a rough go lately, even with positive earnings. While LULU is one of the larger stocks in the industry, its earnings announcement is unlikely to directly affect major indexes. A positive report could lift other stocks in the industry such as Ross Stores, Inc. (ROST), Burlington Stores, Inc. (BURL), or The Gap, Inc. (GPS). It could also affect exchange traded funds (ETFs) such as Invesco's QQQ Trust ETF (QQQ), Emles @ Home ETF (LIV), or iShares' MSCI USA Quality Factor ETF (QUAL).