by Joseph Hargett | May 28, 2014 8:20 am
While earnings season is slowing down, a few key names still have reports on the horizon. Discount retail club Costco (COST), which releases its third-quarter report ahead of the open Thursday morning, is one such company that offers considerable potential for savvy investors. But is Costco stock set to soar, or will it follow fellow retail stocks lower?
If you’ve been keeping track, you know that the big retailing names have not received warm welcomes on Wall Street this earnings season. Specifically, Walmart (WMT) and Target (TGT) were both beaten up after reporting weak income and similar same-store sales despite heavy promotions. Costco stock itself also was pummeled last quarter, as earnings fell 15% due to weaker than expected holiday sales.
That said, COST has seen strong same-store sales growth during the past couple of months — a development that neither Target nor Walmart can claim. In fact, despite poor year-over-year comparisons, Costco saw same-store sales rise 5% in both March and April.
Despite improved comparable sales, Wall Street is hesitant to jump on the Costco stock bandwagon. While earnings are seen arriving up 4.8% at $1.09 per share, and revenue is expected to rise almost 7% to $25.7 billion, estimates have been revised lower during the past month. What’s more, the Costco earnings whisper number arrives at $1.07 per share, or 2 cents lower than the consensus estimate, according to EarningsWhisper.com.
This lack of confidence is reflected by sentiment within the brokerage community, as Thomson/First Call reports that 12 of the 26 analysts following Costco stock rate it a “hold” or worse. Furthermore, the consensus 12-month price-target for COST stock comes in at just $125 — a premium of only 9.7% to Tuesday’s close.
Options traders are placing large bets against Costco stock, too. The May/June put/call open interest of 1.75 indicates that puts nearly double calls among near-term options. Zooming out to the June series, the situation grows even more pessimistic, with the June put/call open interest ratio ballooning to a reading of 2.81.
Click to Enlarge Also, May option implieds are predicting a modest post-earnings move of only about 2.6%. As such, the upper bound lies near $115.58, while the lower bound resides near $110.
As you can see from the chart, the upper bound of COST’s expected move corresponds with overhead technical resistance at $115 and the stock’s 200-day moving average. The lower bound, meanwhile, lies well below first support at $113 and COST’s 50-day trendline.
Bull Call Spreads: With two months of comparable sales pointing toward improving results, and expectations quite low across the board on Wall Street, I’m inclined to bet on a bounce for COST stock following the company’s quarterly report. Traders looking for a potential contrarian play might consider a June $110/$115 bull call spread. At last check, this spread was offered at $3.29, or $329 per pair of contracts. Breakeven lies at $113.29, while a maximum profit of $1.71, or $171 per pair of contracts, is possible if COST stock closes at or above $115 when June options expire.
Selling Puts: Alternately, if you’re not happy with the potential return on the bull call spread, or if you’re just not that confident that Costco stock is set for a rally, a June $110 put sell stands a good chance of capitalizing on technical support. The June 110 put was most recently bid at 58 cents, or $58 per contract. The upside to this put sell strategy is that you keep the premium as long as COST closes above $110 when June options expire. The downside is that should COST trade below $110 ahead of June options expiration, you could be assigned 100 shares for each put sold at a cost of $110 per share.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.
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