Taking Advantage Of Costco's Trading Range

Mar. 1.12 | About: Costco Wholesale (COST)

In a previous article related to Costco (NASDAQ:COST) posted on December 1, 2011, reasons were presented as to why Costco's stock price has peaked and, as a result, a collar position was mentioned as a possible investment for generating income with protection. Since posting the prior article, Costco's stock price has been in a trading range between $79 and $88, as shown below:

A long investor in Costco's stock, if entered on the date of the prior article, would now be sitting on about a 1% loss, however, an investor in the collar position noted in the article would be sitting on a 1% profit, as the net income from selling the call option and purchasing the put option would have covered for the lower stock price and also provided for a profit.

In Costco's most recent Q2 2012 conference call held on February 29, 2012 (yesterday), the company indicated strong results in the Midwest, Northeast, Southeast and in Texas, however the company indicated gross margins were down and inflation was up across the board. The company indicated gross margins were down as the company continues to "invest in pricing." If Costco continues with its "invest in pricing" strategy, at some point the investment could result in a loss. However, in the interim, the strategy is working for the company.

The company now has 600 stores and indicated it is focusing more on expanding internationally, which it should, as opportunities for expansion in the U.S. will be exhausted eventually. Additionally, the company indicated results were negatively affected due to futures contract hedging associated with international currencies.

As mentioned in the previous article, Costco's stock price has peaked, and the current outlook for the price of the stock is to remain in a trading range, at least until the company can really start to ramp up international expansion. Since Costco's earnings release is out of the way for a few months, an investor might consider entering a bull-put credit spread for the company. A bull-put credit spread may be entered at a net credit by selling one put option and purchasing a second further out-of-the-money put option. The goal of the investment is for the put options to expire worthless at expiration with the initial net credit retained as profit.

Using PowerOptions tools, a bull-put credit spread for Costco was found with a potential return of 5.3% (37.7% annualized). The specific bull-put credit spread to enter is shown in the table below:

Click to enlarge

The specific put option to sell is the 2012 April 80 at a midpoint price of $0.38 and the put option to purchase is the 2012 April 75 at a midpoint price of $0.13. A profit/loss graph for one contract of the bull-put credit spread is shown below:

Management of the position for an exit or roll should be considered if the price of Costco's stock drops below $82.50.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.