Costco Earnings Trade Ideas
- Posted by Greg Harmon
- on February 28th, 2012
The big box store where I manage to spend about $1,000 per month on everything is reporting earnings tomorrow morning before the open. I am talking about Costco Wholesale Club, $COST, of course. Naturally I am bullish. This is how it sets up.
Costco Wholesale Club, $COST
Costco Wholesale Club, $COST, rose up to touch resistance at 86 today before pulling back and it is now printing a doji candle into the earnings report. There is resistance above 86 at 88 and then free air to rise higher. Support is found lower at 84.50 and 83.30 followed by 82.50, 81.00 and 80.10 before the low of the year that started the current move higher at 78.59. The Relative Strength Index (RSI) is bullish and slowly moving higher while the Moving Average Convergence Divergence (MACD) indicator is marginally positive. Both reinforce the upward bias in the chart. The reaction to the last 6 earnings reports has been a move of about 1.5% on average or $1.30 at current prices making for an expected range of 83.70 to 86.30. The at-the money March 85 Straddles imply a move of $2.80 by Expiry. Implied volatility at 21% is a little high compared to the historical at 14%, but in line with the April options at 18%. Activity in the March options ahead of earnings has focused on the 85 Calls with over 1000 contracts trading, and the big blocks initiated by buyer. The key is to create a trade opportunity where there is a good chance to win with strong risk management to limit any loss.
Trade Idea 1: Buy the March 87.5 Calls 58 cents.
A low cost way to bet on a move higher after earnings, with downside limited to the premium paid.
Trade Idea 2: Buy the March 85/87.50 Call Spread for 97 cents.
Buying the March 85 Call and selling the March 87.50 Call to create the Call Spread gives you upside participation faster than the 87.5 Calls, for not much more money. Your upside is limited to $2.50 but that would be a 2.6:1 reward to risk ratio.
Trade Idea 3: Sell the March 82.50 Puts for 60 cents.
A bullish bet taking in premium but also exposing you to owning the stock or needing to hedge on a move or close under 82.50 at March Expiry. Your profit is limited to the premium sold.
Trade Idea 4: Buy the March 85/87.50 Call Spread Risk Reversal selling the 82.50 Put for 37 cents.
Combining the Call Spread from idea #2 with the Put sale from Idea #3 gives upside participation for a cheaper entry, and raises a reward to risk ratio to 6.75:1. It also has the same risk characteristics of the Put sale. You may be put the stock.
Trade Idea 5: Buy the April 87.50/80 bullish Risk Reversal for 40 cents.
A longer term bullish bet with a bit deeper downside protection and uncapped upside potential.
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Gregory W. Harmon CMT, CFA, has traded in the Securities markets since 1986. He has held senior positions including Head of Global Trading, Head of Product Development, Head of Strategy and Director of Equity. (More)
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