Costco Wholesale Corporation (NASDAQ:COST) reported a decent sales cycle for the holidays. The company is well-managed, so it shrugged off the onslaught from Amazon.com Inc (NASDAQ:AMZN). COST stock was up 2% on a day when retailers like Macy’s Inc (NYSE:M) were down almost 15%.
Fundamentally, I like COST in the long run. I believe that the warehouse retailer will have continued success implementing on their strategies.
Click to Enlarge Technically, I see potential catalysts just above current Costco stock levels. But I also see some crucial levels that bulls need to hold. This is usually a good set up for premium selling into a an identifiable range.
If the bulls can push past Costco’s recent highs, they could invite more momentum buyers for another push higher. Conversely, if the bears prevail and push COST stock below the $158 per share area, they could invite more sellers and possibly retest $152. This would cover the open gap looming below $156 per share.
For clarity on levels, I will share the weekly longer-term chart, which is more relevant to my levels than the daily chart.
How to Trade COST Stock Now
Trade No. 1: Sell the COST Apr $150/$145 credit put spread for 85 cents per contract. If successful, this would represent an 18% yield on money risked. With a 7% price buffer, I have an 85% theoretical chance of being a winner. For that, I need COST to stay above my sold strike.
I usually like hedging my bet. In this case, I can sell bearish premiums on COST to split the directional risk in half. Movement in either direction would have its pluses and minus to my overall trade. The result would be a sold iron condor. To do that, I need to chose levels carefully.
Trade No. 2 – The Hedge (Optional): Sell the COST April $180/$185 credit call spread for an additional 50 cents. This trade also stands about 85% theoretical chance of success with a potential yield of 11% on money risked. The upside price buffer is 10%.
Taking both trades actually lowers my maximum risk. Why? I collect premiums on both sides but I can only lose on one side or the other. So the total reward is spread on a smaller base.
In case someone is too bullish COST stock through its next earnings cycle, They could replace the hedge trade No. 2 with one that uses SPDR S&P Retail (ETF) (NYSEARCA:XRT).
The Twist (Optional): Instead of selling a credit call spread into COST stock, I do it against the XRT. So, sell the XRT June $50/$51 credit call spread for a 15% yield on the risk at hand. Just note that the balance between this trade and that of the COST credit put spread won’t be 1-to-1. They would be opposed, but not with a perfect inverse relationship.
I am not required to hold any position through its expiration. I can close any of them at any time for partial gains or losses.
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.
