Lululemon: It’s Time to Do a Protective/Married Put

If you believe certain industry experts and analysts, the sky is falling at Lululemon (LULU). 

The Vancouver-based premium women’s and men’s apparel brand updated investors Monday about its revenue and earnings expectations for Q4 2022. While revenue growth is about what analysts expected, its gross profits were lower, not higher, as the company previously guided. 

On a day when the S&P 500 started higher and then moved into negative territory by the end of Monday’s trading, long-time owners of LULU stock might have gotten spooked by the media’s negative spin regarding its business outlook. 

Whether you already own LULU or are considering buying -- I like it under $300. However, I really like it around $250 – it is a good idea to consider a protective/married put strategy. 

Here’s why. 

LULU Could Fall More in the Near Term

Over the past year, LULU stock is down 14.3% compared to -16.7% for the index. They’re both struggling to gain any traction. Yesterday’s news won’t help in the near term. 

Retail Dive reported negative commentary Monday from BMO Capital Markets analyst Simeon Siegel. He questioned whether the latest results are a precursor for more bad news in the future. 

"[W]e fear brand saturation questions are becoming hard to ignore,” Simeon said in emailed comments. “Should we applaud attempts to grab new customers, or ask whether they are hitting brand saturation, which is generally followed by dilution on stretched-revenues, leading early adopters to new emerging brands?”

Having followed Lululemon for a long time, Siegel wouldn’t be the first analyst to question whether Lululemon was losing its cool factor. And he won’t be the last. 

Yardeni Research suggests we’ve been in a bear market for 282 days. You have to go back to 2008-2009 (517 days) for a more prolonged downturn. Given the current state of the markets combined with interest rates moving higher in 2023, there is a good possibility that this bear market could challenge the financial crisis for the most prolonged recession duration since 2000-2001 (929 days).  

While I believe buying under $300 will get you profits five years from now, I don’t think there’s any question that further declines could be in the cards, which is why I’m suggesting a protective put strategy could make sense in this instance. 

What’s a Protective/Married Put?

Fidelity states, “A protective put position is created by buying (or owning) stock and buying put options on a share-for-share basis.” So, technically, a protective put is for existing LULU owners, and a married put is for investors who buy both the shares and the put option simultaneously. 

In this example, you would buy 100 shares of LULU at $300, and 1 put contract with a $300 strike price. As I write this, the ask price on the Jan. 13 $300 put contract is $6.79.

I’m not the biggest options expert by any stretch of the imagination, but I think you would want your days to expiration (DTE) to stretch into April, at least, past its Q4 2022 reporting date. 

So, the May 19 $300 put has an ask price of $27.10. This means that in addition to the cost of the shares, you would be out approximately $2710 for the put option. Therefore, based on $300 per share, your total cost to buy 100 LULU shares would be $327.10.  

Why would you do this?

If LULU were to fall to $250 in the next 80 days, you could exercise or sell the put. Your loss on the 100 shares would be $50 multiplied by 100. However, the put option would be worth $22.90. 

Therefore, if you buy 100 shares at $300 and it drops to $250, you’ve got an unrealized loss of $50 a share. By implementing the protective/married put strategy, you’re out $27.10, which you’ll get back when it returns to the $400s in late 2023 or early 2024.

Why Should You Like the Long-Term Prognosis for LULU?

Jefferies analyst Randall Konik is bearish about Lululemon. In December, Konik reiterated his Underperform rating and a $200 price target on its stock. 

“‘We believe Lululemon’s fundamentals have peaked and believe the company’s long-term growth projections are unachievable,’ Konik said in remarks provided by Jefferies, adding, ‘We see a lot of downside risk for Lululemon shares,’” Barron’s reported on Dec. 15. 

Konik, however, has been a LULU bear for many years. As far back as 2016, he was skeptical of its ability to deliver on its margins. 

“We’ve closely monitored the ‘We Made Too Much’ section of LULU’s website and have observed heightened promo activity, which stands to threaten the significant GM [gross margin] expansion expected for 2H [second half] and potentially speaks to softening trends,” CNBC reported his comments in October 2016. 

LULU stock is up more than 470% compared to 82% for the index in the 75 months since. Konik has spent considerable time rating it either Hold or Underperform, with the occasional Buy rating.

Most of the media coverage of yesterday’s update either centered around lower margins or higher inventories. 

However, as CEO Calvin McDonald said in December, it hiked inventories in 2022 to avoid disappointing customers, as it did in 2021 when the company ran with leaner inventories. 

Inventory management isn’t an exact science. When you raise inventory levels, you run the risk of having to increase the number of promotions you do. So, in Lululemon’s case, its Q4 2022 gross margin will be 100 basis points lower than 58.1% in Q4 2021.

Based on $2.7 billion in Q4 2022 revenue at the high-end of yesterday’s guidance, the 100 basis-point decrease from last year works out to a $27 million decline in its gross profit over what it would have made from the Q4 2021 gross margin. 

Twenty-seven million dollars in gross profits is a fair trade for keeping your customers happy during the holiday shopping season.

Refrain from falling for the short-termism that plagues analysts. It’s insidious. 

As for potential competitors, I’m at a loss who they could be. Really. 

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