Two weeks ago (read here) I previewed Costco’s (COST) fiscal Q1 earnings (reported last Thursday). It was my view that the stock’s 20% rally in two months, since reporting disappointing fQ4 results in October likely discounted any good news in the near term. The company did beat expectations, and the stock rallied 3.3% on Friday, sending the stock to a new all-time high. But since Friday’s opening the stock has declined nearly 5%, more than filling in the earnings gap, and now threatening the sort of pull-back that I had been playing for prior to results. This is a good opportunity to check in on the trade idea from Dec 8th:
TRADE IDEA: COST ($188) BUY JAN 185 / 175 PUT SPREAD FOR 2.50
-Buy 1 Jan 185 put for 3.65
-Sell 1 Jan 175 put at 1.15
Break-even on Jan Expiration:
Profits up to 7.50 between 182.50 and 175, max profit below 175
Losses of up to 2.50 between 182.50 and 185
At this point, with the stock at $185.95, this put spread can be sold at $2.35 for a small loss. For a couple of reasons I am inclined to close the position and move on at this point. First I was wrong on the fundamentals, but the price action is bailing me out for a much smaller loss than I had on the position Friday morning. Second, this trade shows how difficult it is to trade options from the long side into events like earnings. As regular readers have heard me say on many occasions, you need to get a lot of things right to merely break-even on long premium directional earnings trades, timing, the magnitude of the move… and obviously direction.
The trade itself is still out of the money, with a break-even at 182.50, nearly 3.50 lower than where the stock is currently trading.
Action: Sell to Close COST ($185.95) Jan 185 / 175 put spread at 2.35 for a 15 cent loss.
For those who find the stock’s suddenly negative reaction to good fundamental news encouraging from the short side, then it makes sense to hold on and play for a move back the gap level near $180 in the near term, with a quick trigger to take the small loss if the stock bounces.