Update Dec 11th, 2012: COST reports fiscal Q1 earnings tomorrow before the opening. The options market is implying about a 2.25% move following the report, which is rich to the 4 qtr avg and 8 qtr moves of only ~1.4%.
Last Wednesday, hours before the stock went ex-dividend for their $7 special dividend announced a couple weeks earlier, I bought at the money Dec 105 puts in (now the Dec 98 Puts excluding the spec div) with the thought that there was a lot of money chasing the stock, as it made new all time highs. But with earnings in a week or so some traders would look to exit the position prior to the event and avoid any potential uncertainty.
With the stock now trading $98.70, the stock is basically back at the highs with the div and I have been wrong about the near term price action in the stock and the broad market.
I want to make one important point here, the Company is not likely to miss and guide down a few weeks after they agreed to return cash to shareholders that equals their entire cash pile on their balance sheet. This was never a fundamental trade, this was based on a few technical factors, sentiment, and the cheapness of implied volatility.
So now with 3 hours before the close, I have to consider my options as I head into today’s close:
1. I can close the position for about a .45 loss (with the stock 98.70, I can sell the Dec 98 Puts at 1.35). I would do this if I had little conviction that the stock would sell off in the next week regardless of how good or bad the earnings news and guidance is.
2. I can turn into a vertical put spread by selling a lower strike put to reduce my break-even. For instance with the stock at 98.70 I can sell the next lowest strike, the Dec 95 at .55, almost equal to the loss of the 98s that I own and have a $3 wide Put Spread on for 1.25, not a great risk reward, risk 1.25 to make 1.75 if the stock sells off more than the implied move over the next 8 trading days.
3. Leave the position as is and let the puts ride given how cheap the implied vol is in the name with the chance that there is no real incremental buyer left in the name with the stock likely discounting a fair bit of good news.
4. Roll the bearish near term view out a bit to give myself some more time. For instance with the stock at 98.70 I could buy the Jan13 98/93/88 Put fly for .90, while this is not exactly a cheap fly, I am looking at it more as a 1×2, but covering my wing. Or I could buy the further out of the money Jan13 95/93 put spread for .42, playing for a larger move over a longer period of time, risking less, but also limiting my profit potential on a big move with a much lower probability of success. I would likely lean towards the fly as it would carry better on little movement throughout the holidays, but neither seem that compelling at the moment, as the best thing to do may be to clear the decks and look to re-initiate the trade on any strength after the event.
I will be making a decision in the next couple hours, so stay tuned.
Original Post Dec, 5th, 2012: New Trade $COST: Fading the Div Enthusiasm W/Stock at All Time Highs
Event: report fiscal Q1 earnings on 12/12/12 (prior to the open), the options market is implying about a 2.5% move vs the 4 qtr avg of about 1.5%.
COST has been a monster this year, up nearly 26% and just today making new all time highs. The company has been the beneficiary of the predominate exposure to North American consumers, while they have been taking share from other wholesale retailers. The company has nearly 10% of their market cap in cash, and has recently decided to payout a $7 special dividend, which would equate to almost their entire cash balance at current levels. Since their Nov 28th announcement of comp store sales that were inline with analyst expectations, and the announcement of the special dividend (stock goes ex-div tomo) the stock has been up 9%.
Technicals: The recent break-out to the upper end of the uptrend that has been in place from the lows in 2009 could be getting a bit extended and could re-trace back to $100 or so on any disappointing news.
Valuation: Despite the company’s stellar performance in a difficult retail environment and their generous agreement to return cash to shareholders, the stock at current levels is getting quite expense relative to it’s historical valuation range. Looking at the chart below of the 7 yr PE range it becomes evident that it is getting a tad stretched trading at 23x next years expected earnings of $4.50.
MY VIEW: the stock of late has benefited from market participants gaming the special dividend payment, lots of cash has rushed into the name in the last weeks. My sense is that so of the “fast money” could look to exit the stock as we get past the ex-date and if especially if there are any fundamental negatives from next week’s earnings report.
While I generally shy away from buying or selling stocks on valuation, taken as one of many inputs, COST lines up as a decent near term trading short. Vol is cheap, and at the money options look like the way to play from a directional stand point, I am starting with an outright put purchase but will look to leg into a vertical on any weakness prior to earnings.
TRADE: COST ($105.28) Bought the Dec 105 Put for 1.80
-Bought 1 Dec 105 Put for 1.80
Break-Even on Dec Expiration:
-Profits with stock 103.20or below
-Losses of up to 1.80 btwn 103.20 and 105, max loss of 1.80 above 105.