Traders and investors went on a shopping spree in the broader market Monday, but saw plenty of returned merchandise on Tuesday. Amid the indecisive investor action, retail club warehouse operator Costco (COST) looks prone to further downside pressure and offers bearish traders the opportunity to shop for a drop in Costco stock.
Just over a month ago, conditions were quite conducive technically for Costco stock bears. Shares of COST had been trading lower for nearly five straight months from all-time highs and were off by about 14% for the period.
Costco’s pricey fundamentals compared to its competitors may have assisted in that corrective downtrend. But with shares of COST stock gaining ground this past month, COST still is expensive by metrics like its trailing P/E and price-to-book ratio versus its peer group.
Hedge funds were early supporters of the previous downtrend in Costco stock. Data shows the smart money as having reduced its collective stake by 7.84% and the outright number of funds showing COST stock on their books slipped from 44 to 41, according to Insider Monkey. Then came Piper Jaffray and an upending of the bearish action in Costco’s stock price.
On July 7, Piper analysts came out to defend their “overweight” rating and $154 price target on Costco stock. The firm cited investors failing to price in Costco’s Visa (V) deal and potential membership fee increases.
Lo and behold, investors did find themselves doing more than just listening as COST stock spiked by more than 3.5% that day — and the Costco stock price has continued to gain ground of around 4% over the last month.
COST Stock Chart
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And given that the company’s largest shareholder is Berkshire Hathaway (BRK.A, BRK.B) — led by Warren Buffett, a guy that’s supposed to know a thing or two about value — that might seem all the more approachable, right?
Costco bulls might also gladly point to shares of COST as being above both the 50-day and 200-day simple moving averages, and as having found support from the latter in the last couple weeks.
But in playing devil’s advocate, bears looking for a technical case might want to focus on other important items. In our view, resistance can be found from an existing bear cross, Costco stock’s Bollinger Band that it’s bumping up against and a price consolidation bouncing between the 38% and 62% Fibonacci levels.
In arguing further for the bear case, Costco stock offers a solid risk-to-reward proposition for traders using the 62% retracement level near $148.50 as a stop-loss. That’s about 1.5% of Costco’s price risk and an important level for bears to defend.
Ultimately, a failure by bears to hold the Costco’s 62% level as resistance would change the dynamics of COST and put it in position to test its prior highs. As for the downside and profiting from the move, if Costco stock retests its July lows near $135, that would amount to a drop of around 6.5% — more than four times greater than the risk outlined above.
There are of course multiple price levels along the way where Costco stock could find a low without ever testing the $135 area in shares of COST. But first things first — let’s shop for the anticipated drop with an affordable and well-constructed trade that could do well without requiring a heavy price discount in Costco stock.
Costco Stock Options Strategy
At last check Wednesday, with Costco stock near $144.25, the September $145/$140 put spread for a purchase of $1.90 or better is an overall nice fit. The breakeven of $143.10 is less than 1% lower.
If shares of COST trade below $140, at expiration the spread would net you $3.10 in profit for a good return in excess of 160% in a little more than a month’s time for a move of around 3% in Costco’s stock price.
And if Costco fails to cooperate?
The bearish trader using this COST spread should be able to return the position to the marketplace for about half-price or around $1 if the 62% retracement level near $148.50 is applied as a stop-loss in the next one to two weeks.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.
