Most investors depend too much on picking perfect entry points, but you don’t need to do that when you trade with options. Consider Costco Wholesale Corporation (NASDAQ:COST) which fell 4% on Monday, related to the $7 special dividend it recently announced.
I am a fan of Costco stock and its stores, but when I wanted to go long a week ago, I didn’t buy shares outright. I didn’t want to risk $173 per share without any room for error, so instead I did a trade that delivered fast profits and with zero out-of-pocket expense.
Click to Enlarge By selling options into uncertainty, I collected elevated levels of premium that got severely deflated in my favor after the hoopla passed. Now I can reset long knowing I have profits in hand and with more clarity for the mid-term outlook.
Fundamentally, Costco is a proven performer, and unlike the rest of retail has not been demolished by Amazon.com Inc (NASDAQ:AMZN). Experts would tell you that COST stock is expense at 30 times trailing price-to-earnings, but I still would rather pay 30 times for that rather than the so-called “cheap” 15 times for Macy’s Inc (NYSE:M) or Kohl’s Corporation (NYSE:KSS).
Unlike M or KSS who are dying on the vine, COST has respectable growth rates, and if you visit their stores you can literally get a free lunch from the yummy samples.
Today, I want to share a trade that will generate income by selling downside risk in COST stock. The key is to find proven support levels that will hold up, even in the face of a sizable correction. I only do this in quality stocks like Costco, where the fundamental outlook supports the idea that bulls will step in if the stock sells off.
My Trade on Costco Stock
The Bet: Sell the COST Oct $148 put, a bullish trade for which you collect $1.25 per contract. However, with this trade, you are committed to buying shares at that price, and anything below $146.75 would accrue losses.
You could spend 10 cents buying temporary put protection through June and into the next earnings release.
For those who prefer a limited-risk profile, I can change this trade to a credit put spread, where the maximum loss is finite.
The Alternate: Sell the COST Oct $148/$143 credit put spread. Even though this has limited risk, the reward is still a 7% yield. That doesn’t sound like a lot, but it sure sounds better than needing to risk $173 per share of COST stock, then needing prices to rally 7% just to match the spread.
E-mail sellspreads@gmail.com with questions or join me to learn more about options in a personal 1on1 webinar here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
