I’ve put together a long signal out in ULTA Salon, Cosmetics & Fragrance (ULTA). They are set to announce earnings on June 10 after the market close.
I looked at a lot of different set ups but came down to two different broken-wing butterflies. It was either the June 90/97.5/100 broken-wing call fly for $1.50 or the 92.5/97.5/100 for $0.80.
Which one do you do? As always, I have to consider context. Clearly, I can make more money in absolute terms from the 90 one. Its max value is $6.00 (7.50-1.50) and the 92.5 one maxes out at $4.20 (5.00-.80).
But, where are we actually expecting ULTA to go to after earnings if we are in fact correct on our bullish call?
Key Considerations
When considering an earnings play, I can look at three things: prior earnings, the measured move priced by the option market and technical analysis. Over the past two years, the average move on earnings for ULTA has been 12.2%, the options market is pricing just about the same move depending on how much weight you want to give to the rest of the time to expiration after earnings, but 12% is a reasonable number.
The Chart
From a technical standpoint there is quite a lot of room for an upwards move and I can easily make a case for significant resistance not coming in until we get above $95.00 perhaps even the $98.00 level. Given these factors with ULTA presently trading ~$86.15 I am targeting $96.70.
Let’s say I am going to risk $1000 worth of premium in this signal. If my forecasts are correct the 90/97.5/100 broken-wing call fly would be worth $6.70 less the $1.50 or net $5.20 and with our $1000 we could purchase 7 contracts. My net profit would be $3,640 (6.7-1.5=5.20*7*100). Using the same investment, I could buy 13 contracts of the 92.5 set up. This spread maxes out at 3.40 (96.7-92.5=4.20-.80).
Reward
My profit would be $4,420 (3.40*13*100). Given my forecast price (not assuming a max out of each spread) the reward to risk for the 90 spread is 3.47:1 and the 92.5 spread has a reward to risk ratio of 4.25:1.
