Costco Wholesale Corporation (NASDAQ:COST) reported earnings after the bell Thursday, May 26, and investors liked what they saw. Wall Street is driving COST stock higher on Friday — a welcome respite after a tumultuous past few weeks for the otherwise solid performer.
Costco is one of a few retailers who are able to thrive in the age of Amazon.com, Inc. (NASDAQ:AMZN). Management has been near flawless with execution, while others like Macy’s Inc (NYSE:M) are scrambling to stay alive.
So far, Costco has proven Amazon-proof.
Fundamentally, Costco stock isn’t cheap if you compare its price-to-earnings ratio to the rest of the retail sector. But that’s an unfair comparison considering that retail is in shambles except for a handful of exceptions. I admire Costco’s ability to maximize its assets as much as I enjoy shopping there.
Click to Enlarge Technically, I can say that it’s never an ideal time to commit long a stock near highs. But perfect entry opportunities are fleeting for some fast-moving stocks.
I overcome this by using the options markets so I don’t have to be surgical with my timing.
I have been successful trading COST stock. In fact, just last week I shared a trade that delivered fast profits and with zero out-of-pocket risk. Now armed with profits in hand, I can commit to a longer-term trade, and with more conviction.
The thesis that I used to enter last week’s trade is still viable. I just need to adjust the levels and time until expiration. There will be a difference in risk levels, however. Longer-dated options allow for bigger buffers, thereby reducing the risk profile.
How to Trade COST Stock
The trade: We want to bet that Costco stock will not fall 8% by July of this year. If it does, then we should be willing and able to own it. For that risk we collect a premium now, which means that we would accrue losses below $162.25 per share. So, sell the COST Jul $163 puts for 75 cents. We have an 85% theoretical certainty that we will retain my maximum gains. For that, we need Costco to stay above my strike.
Selling naked puts is not ideal when markets are near all-time highs, but with a 8% buffer, I am confident that I will be able to manage my risk against shorter term price gyrations.
If you’re not willing to own COST stock, then you should turn this into a credit put spread. The risk profile is tighter there, but the trade can still yield 11%.
Compare this with risking $177 now and with no room for error, then hoping the stock rallies 11% just to match the performance of the spread. Clearly, options make more sense here.
Selling options is risky business, so never risk more than you are willing to lose.
Learn how to generate income from options 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.
