Costco Wholesale Corporation (NASDAQ:COST) stock went on sale several times in the past 12 months and we bought it in bulk and we profited every time. Today, I want to go long COST stock, but this time it’s a little different.
Since Costco stock is at all time highs, I need to adjust my strategy to account for the upcoming earnings report.
In 2017, things were shaky for a while thanks to headlines from Amazon.com, Inc. (NASDAQ:AMZN). In June, COST stock fell 15%, but it has since recovered and set new highs. COST reports earnings tomorrow after hours and the stock is coming into it near all-time highs.
How to Trade COST Stock
I am a fan of the store and Costco stock, so today, I want to go long, but since the risk of earnings is hours away, I want to temporarily guard against a potential dip. Earnings reports are binary events. The short-term reaction to the headline is a complete guess regardless of the quality of the numbers management delivers.
While its 17% year-to-date jump is impressive relative to the flat SPDR S&P Retail (ETF) (NYSEARCA:XRT), COST stock still lags the retail star Wal-Mart Stores Inc (NYSE:WMT). Nevertheless, it shows that COST management is doing the right things to survive the AMZN era.
Fundamentally, COST is not outrageously expensive, but it’s not a screaming bargain either. It has a price-to-earnings ratio over 30 and for a retail stock that is high. It’s even higher than WMT whose stock is up twice as much as COST. For absolute comparison consider the fact that Apple Inc.’s (NASDAQ:AAPL) P/E is under 19.
Technically, Costco stock is filling in a trend-line breakout that happened on Nov. 29. The move brought the stock to new all-time highs. From here, if the bears were to exert downside pressure, they’d want to retest the neckline area, which is around $178-per-share.
From a longer term perspective, I see that on the last correction, COST stock bulls defended the $152-per-share zone with gumption. As long as the macroeconomic conditions persist, I expect they would do the same again.
The Bullish Trade: Sell the COST Apr 2018 $155 naked puts and collect $1.20 to open. Here, I have an 85% theoretical odds of winning, but if the price falls below $153.80, I would own shares and accrue losses.
Selling naked puts carries big risk, especially when a stock is at all-time highs and going into an earnings report. So, to mitigate some risk, I will hedge my bet with a temporary bearish spread.
The Bearish Hedge: Buy the COST Jan $180/$178 debit put spread for 50 cents. If the price falls through my spread, then I have a chance to triple my money.
Taking both trades would result in a net credit. So, as long as COST stays above my bullish trade, then I am a winner already. I have until mid-January to close my bearish bet. And any premium I recover from selling it to close would be incremental profit.
Ideally, I want COST to fall through my spread in the next few weeks, but hold above my bullish trade. This way, I can close the debit put spread for a profit and let the bullish premium expire for maximum profits in my favor.
Ultimately, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free 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 as @racernic on twitter and stocktwits.
