Lululemon stock has pulled back from the recent high and is showing high implied volatility.
As option traders, we can take advantage of that high volatility by selling a short strangle.
A short strangle involves selling an out-of-the-money put and an out-of-the-money call with the same strike price and same expiration date.
This trade generates a large amount of premium for the option seller, but it does come with risks. A short strangle is an unprotected trade, sometimes referred to as a "naked" trade. Naked options can be risky because they expose the trader to potentially unlimited losses if the stock makes a big move.
However, if the trader is right and the stock trades sideways, the trader gets to keep the full premium.
Trade Generates $720 In Premium
Assuming traders believe that Lululemon stock will trade sideways over the next few weeks, they could look to sell a Jan. 17, 360 put and a Jan. 17, 410 call.
The 360-strike put could be sold for around $3.90 and the 410-strike call could be sold for around $3.30.
Selling those two options would generate a total of $720 in premium. That is the maximum possible gain on the trade if Lululemon stock closes between 360 and 410 on the day of expiration.
To work out the breakeven price of the trade, take the lower strike price of 360 minus the total premium received of $7.20. That results in 352.80.
Then on the call side, take the call strike and add the premium, which gives 417.20.
Rise In Implied Volatility Would Be Bad
This is a short vega trade, which means if implied volatility increases early in the trade, losses could occur.
Short strangles are an advanced option strategy, so if all that sounds confusing, it's best not to trade them.
With a trade like this the potential losses are unlimited and a lot higher than the potential gains. So traders would want to be very confident that the stock is going to remain flat over the course of the trade.
A stop loss could be placed at the short-strike prices.
According to the IBD Stock Checkup, Lululemon is ranked No. 4 in its industry group. It has a Composite Rating of 91, an EPS Rating of 95 and a Relative Strength Rating of 84.
Lululemon is set to report earnings in late March, so this trade should have no earnings risk.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
