Thursday was a tough day for the equity bulls. The indices fell sharply ahead of the jobs report. Investors are nervous over skyrocketing interest rates.
Most notable is the 10-year bond yields. Investors fear that as the yield 3.25%, it will become harder for stocks to rally in the face of an alternative that pays.
So it was unfortunate that Costco (NASDAQ:COST) had to report earnings on an afternoon like that. Investors sold COST stock down hard on the knee-jerk reaction on the headline.
Even though COST management grew sales and net income from a year ago there were concerns. Online sales and cost controls were two, and management warned of material weakness in its internal controls.
While this sounds serious, Costco is a quality company with a proven track record. They succeeded during times when most other retailers failed in the face of the Amazon (NASDAQ:AMZN) juggernaut. So it deserves the benefit of the doubt.
However, the stock came into the earnings event up 23% on the year, so a small dip is not going to change the fundamentals of the company.
COST stock is not expensive even at this level, selling at 32 price-to-earnings ratio. But it’s not a screaming by either. So I don’t risk my money to buy the shares outright here without any room for error.
Instead, I use the options where I can set a buffer between current price on my level at risk. The worst-case scenario on this trade setup is that I own shares of COST stock at a deep discount from this level.
Technically, a stock that runs this fast and in this short of time becomes vulnerable to small corrections. Rising wedges often break, but in this case we have visible proven support levels below at $220, $210, and $200.
The macroeconomic environment even in the face of rising races still is favorable to owning quality stocks. The business of companies like Costco or Apple (NASDAQ:AAPL) or Alphabet (NASDAQ:GOOGL) are not going to fall off a cliff just because the interest rate is now a quarter point higher.
COST Stock Trade Idea
However this causes unease which brings about hesitation to buy upside hopium. With today’s trade I don’t a rally to profit. I merely need support to hold so I can retain my maximum gains.
I am confident that if I own Costco stock at a discount from here I will profit from it in the long term.
The Trade: Sell COST Jan $190 naked put and collect $1.40 to open. Here I have a 85% theoretical chance that I would retain maximum gains. But if price falls below my strike then I accrue losses below $188.60.
Selling naked puts is daunting. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell COST Jan $193/$190 credit put spread. The spread has the same odds but would deliver 12% yield on risk. Neither trade require a rally to profit.
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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.
