Lemonade Stock: Unusual Call Volume Highlights Sweet Trade

Key Points

• Lemonade bulls were disappointed by guidance, but a new opportunity has arrived. 
• Sell-side activity is consistent with a trading range that traders can target. 
• Covered calls could bring in 8% to 10% monthly in March and April.

Lemonade NYSE: LMND turned up on Marketbeat’s radar before the Q4 release, popping up for unusual call volume activity, highlighting its tradability if not a good trade. Investors hoping to cash in on a ramp in share prices were disappointed by the guidance, which soured the market and shaved nearly 30% off the share prices. The takeaway for today is that Lemonade continues to experience unusually high options activity and may see additional volatility this month, meaning it is still a good target for options traders. But what trade?

The Technical Outlook: Lemonade Is Stuck In a Range-Sell Covered Calls

Lemonade is stuck in a trading range and unlikely to move outside it soon. The floor is near $15.50, the ceiling near $20, setting a solid range for traders to target. Because the company is expected to pivot significantly during the year, LEAPs and long-term calls may be a winner. LEAPs and long-term calls provide a cheaper entry than buying the stock and can be used as collateral to sell covered calls until the next catalyst emerges. 

Covered calls could provide income while the stock price moves sideways within the range but will cap gains if the stock moves up to a new high, so traders should keep this in mind when planning their traders. 

The next visible catalyst for the stock isn’t until May when it reports for Q1, which is three months away, plenty of time for covered call traders. However, the guidance may have set this company to deliver a positive catalyst when it reports. The company expects about $112 in revenue, which is up YOY but sequentially down despite an expectation to increase its in-force premiums and a history of outperformance. 

The company may outperform because it is an AI-powered insurance platform in its early growth phase. The company has been increasing revenue steadily and plans to double its investment spending this year, increasing its business book. Among the highlights from the Q4 report is guidance for accelerating growth in 2024 and a pivot to positive cash flow in 2025. 

One scenario for traders today is buying a call with a $14 or $15 strike price and expiration in June or July. Those are running in the $4 to $5 range and provide enough time to sell two calls, one in March and one in April, and possibly another short-duration call before earnings. Sold calls will be at the high end of the range and may bring in as much as $0.40 per contract or 8% to 10% monthly income.

Insiders And Analysts Help Drive Volatility

The sell-side activity is mixed in Lemonade but consistent with a trading range. Insiders and institutions own a substantial amount of the stock, and activity supports the market, but the analysts aren’t buying. Analysts rate Lemonade as Reduce, leading the market lower with their price target revisions. The consensus target firmed slightly following the Q4 release but is down 35% YOY and is 15% below the current market, so it will weigh on action for the foreseeable future. 

Institutional holdings are solid, helping to limit the downside risk. The institutions bought consistently from Q2 2023 to Q1 2024, raising their ownership to 55% while helping the market to bottom. Ownership is about 50/50 funds and private equity, including large holdings by Vanguard and Baillie Gifford & Co. Baillie Gifford & Co. is a Scotland-based independent investment advisor focused on game-changing assets that can sustain long-term growth. It is the 2nd largest holder. 

Risks Are Present For Lemonade Traders, But Rewards Outweigh

The downside risk is minimal for this tech stock but still present. The company’s lack of profits and uncertain trajectory have the short sellers interested, and the short interest is high. The last report had short interest above 30%, unlikely to change soon, so volatility should be expected. The worst-case scenario is that short-sellers will drive the action below critical support, which is unexpected.