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Why a huge move could be ahead for Lululemon

Lululemon is set to report earnings on Thursday, and traders expect to see a huge move out of the athletic apparel company.

The stock is already moving on Tuesday, rising after Wells Fargo upgraded the name from "market perform" to "outperforming."

But the big action could come on Thursday, with the options market is implying a 10 percent one-day move for the stock, according to Dan Nathan of RiskReversal.com. That might sound gigantic for a company worth $6.5 billion, but it is actually a bit less than the stock's average post-earnings move of 12 percent over the past four quarters.

The moves haven't all come in the same direction, either. Last quarter, the stock opened 14 percent higher after reporting earnings. And the quarter before that, the stock opened 16 percent lower.

Jim Duffy, an analyst covering the stock for Stifel Nicolaus, explains that the sharp moves are partially a result of the company's levered business model.

Lululemon, like many other retailers, has "a lot of leverage to sales, and that can cut both ways. If sales momentum is strong, earnings can accelerate, and you get both the earnings acceleration and multiple expansion (and vice versa)," Duffy wrote to CNBC. "The range of potential outcomes for the stock one year from now is very wide."

But there's something else, too. Lululemon had been a big momentum stock, before the momentum turned the other way. Now, a war is being waged in the market.

"This is a battleground stock, and heavily shorted, so you can get either a short squeeze or short pressure following the quarterly numbers," Duffy said.

A Lululemon retail store in San Francisco
Getty Images
A Lululemon retail store in San Francisco

So which way will it break this time?

On Monday, the big bets were that the stock is set to surge. Four times more calls were traded than puts, which indicates that traders were making bullish bets. And in the day's largest trade, a trader bought 1,200 March 45-strike calls for $4.35 each.

This $522,000 bet will only make money if Lululemon shares rise above $49.35 by March, which is 10 percent above where they closed on Friday.

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