Friday, September 6, 2013

The mother of all earnings lotto ticket - $LULU

The mother of all earnings lotto ticket - $LULU Posted on Sept. 3, 2013, 6:22 p.m.

Find it here:
LuluLemon reports earnings before the market opens on Sep 12th. Here is statement that always seem to spur heated debates: investing going into a company's earnings report is gambling! The argument for this is that traders cannot predict how the markets will react to earnings reports regardless if the quarter is a miss, meet, or beat with raised or lowered guidance.
This doesn't mean that traders should stay completely shut out of earnings events. Thanks to the option chains, traders can still participate in the earnings with lotto style trades. Those are trades with minimal costs, well defined risks, and a decent return IF they hit.
A good candidate for such lotto earnings trades is crowd favorite LuluLemon. It is still too early to pick a stance on the stock but traders can start working on the set up. The one year chart below clearly shows why lotto trades in LULU have a good chance of working well for those who guess the direction correctly. Meanwhile, here are a few points of contention to consider before trading earnings lotto style:
  1. Here is a good make up of a lotto trade:
    • Stock with violent reactions to earnings releases
    • Preferable a stock with weekly options (tho not a requisite)
    • Stock that has decent options volume
    • Defined risk usually nothing more than the price of the option position
  2. The direction decision: this is the coin flip moment! Traders have one chance at calling it right.
    1. One can go with the flow and take the same position as the market expectations
    2. Once can go against the grain and take a contrarian position to market expectations
    3. One can also pull a Constanza: make the decision and then take the opposite direction (it recently worked for me on CRM earnings;-)
  3. The magnitude of the move: Equally as important as guessing the direction of the move is guessing its magnitude. It pays nothing to correctly guess that Lulu will fall on earnings but choose a trade that is so far out of the money that it won't participate in any meaningful options premium appreciation even after the move.
  4. Recap: to hit the earnings lotto trade with a proven earnings mover, traders need to guess up or down (that's a 50/50 chance). Although traders need to also choose a good level, the chances for success are still darn close to 50%.
A skeptic might ask then why would investors not want to buy a real lotto ticket instead and have a chance at millions? Simple: a 50%ish chance of loss (here) is way better than 99.99999% chance of loss with a 'real' lotto ticket.