How to use options to trade Lululemon into earnings

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Time to add some Zen to your portfolio

Don't look now, but Lululemon is on the verge of doubling up its value in 2019.

The hot athleisure stock reports earnings on Wednesday, and after rival Nike hit a new all-time high on Friday, Optimize Advisors President Mike Khouw and "Fast Money" trader Guy Adami wondered whether the optimism would flow through to Lululemon.

"Look at what they did last quarter in China," said Adami. "China growth — 68% ... that's a real number. Also, margins are improving in this environment. Operating margins better than expected, comps — crazy — up 17% last quarter."

"I don't mention valuation because it's very hard to make a cogent argument about valuation, but this is a stock that, into earnings, I think continues to go higher."

Lululemon has had a remarkable year, but as Khouw views things, it's difficult to get too excited about a stock that has already run so far.

"The stock has had a 90% run so far this year, and it's obviously very challenging to go out and commit new capital to stocks that not only have had such a profound move, but are also trading at such a high multiple," said Khouw.

Khouw also noted that options premiums in Lululemon are elevated right now as the stock gears up for earnings, and the stock's high valuation makes him wary of making a directional bet into a catalyst like earnings.

"In a situation like this, based on the price action and based on the valuation, and based on the options premiums, we know that there are some very high expectations," said Khouw. "Maybe there's a way we can participate on further gains in the stock without risking a great deal."

As it turns out, there is.

Instead of making a purely directional bet, Khouw illustrated how to trade the December/January 250-strike call calendar, a trade that would be profitable if Lululemon shares are between $222.90 and $283.40 by December expiration.

"This is going to see the best profits if the stock migrates right up to that $250 area, and actually will remain profitable if it doesn't blow out past $283. Now, bear in mind, the average analyst price target on the stock right now is about $247," said Khouw.

Lululemon was trading about 1% higher on Monday morning.

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