Amazon.com Inc (NASDAQ:AMZN) announced on Thursday that its acquisition of Whole Foods Market, Inc. (NASDAQ:WFM) would close Monday, and that it would roll out new perks such as cheaper goods and making brands like 365 Everyday Value available on Amazon Prime. This caused a crash in grocery-connected companies such as Wal-Mart Stores Inc (NYSE:WMT) and Costco Wholesale Corporation (NASDAQ:COST). The losses were deep, too, with WMT and COST stock dropping about 5% on the news.
Panic selling on Wall Street opens the door for opportunities. More often than not, the selling gets overdone quickly. And we can create free income by betting against those unlikely scenarios.
Today, I want to look at Costco stock.
Yes, Amazon’s ownership of Whole Foods is an undeniable threat to grocery companies. But I believe Wall Street is overreacting. Companies of the caliber of Costco or Walmart likely won’t be decimated like the department stores were. These two are masters of running thin-margin operations, so they’re better prepared to fight Amazon than, say, Macy’s Inc (NYSE:M).
Fundamentally, Costco stock is not cheap. It trades at 26 times trailing earnings and, as mentioned, boasts relatively thin margins. But it has earned a premium thanks to operational consistency. Management doesn’t give traders many specific reasons to sell. In a bullish macro environment, COST is guaranteed to deliver results.
Click to Enlarge From a technical standpoint, Costco shares were, before Thursday, setting higher lows and knocking against a breakout opportunity. Unfortunately for the bulls, Thursday’s headline sparked a deluge of selling that caused a 5% dip within minutes. For the short-term, bulls of COST stock must defend $150 per share. Otherwise, shares will retest the $142 zone.
Amazon’s ownership of Whole Foods will become effective next week. However, the financial impact on Costco, if any, won’t materialize for months. Traders tend to price all the bad news at once, and they often overreact.
How to Trade COST Stock
The bet: Sell the Nov $135 put for $1.50. This opens my risk, but I have an 85% theoretical odds that price will stay above my strike. If not, I would become a buyer at $135, and I could accrue losses below $133.50.
Selling puts when markets are near all-time highs is daunting to some traders. So they can sell spreads instead of naked puts and limit the risk at hand. Their maximum loss would be limited by the width of the spread.
The safer bet: Sell the Nov $135/$130 credit put spread, which offers roughly the same chances of success. If I win, the spread would deliver 11% in yield.
In either of my setups, we’re not betting that Costco stock will rebound or rally. All we’re betting on is that COST shares will stay above our risk levels, which will allow us to retain maximum gains.
Since I’m using options, my trade has 10% room for error. This is much better than buying shares outright and risking $150 right here, without any buffer.
Investing in the stock market never comes with guarantees. Never bet more than you can afford 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.
