Piggyback Profits on Retails Monster Day

Earlier today, two key retailers announced their fourth-quarter and fiscal 2018 earnings. Both blew away expectations.

Target announced top and bottom-line growth – above analyst expectations. It also released a very enthusiastic forecast for the rest of 2019. Kohl’s did the same.

The driver for Target at least, and its larger rival Walmart a few weeks ago, was expansion into online sales. Now, here’s one advantage these two – and to a lesser extend Kohls and a few other retailers – have is the click-to-brick model. This is where customers can order online and pick up in store. Amazon, the 800-pound gorilla in the room, doesn’t really compete on that front.

That said, not everything was amazing in these announcements. Target’s CEO came out on CNBC this morning to promote his company’s performance. But he let something slip.

He noted that consumer confidence is “stable,” and that “it’s going to ebb and flow.” But it’s a “consistent consumer environment.” That’s very different from “the best he’s ever seen” just a few months ago.

None of this is to say that Target is in any way in trouble. Or that it won’t be able to meet its goals. But it puts another upcoming retail giant’s earnings into a different light.

Costco announces its earnings in two days. It operates in a somewhat similar market as Target and Walmart. But in another way, it has carved out a very unique niche.

It does directly compete with the likes of Walmart’s Sam’s Club. But Costco’s business swamps that competition. It also offers a far different type of service than Amazon. Its bulk discount warehouse model offers consumers extreme convenience even the likes of click-and-brick operations don’t.

While the company hasn’t released its latest financial results, it has announced its latest sales figures. It is growing at 8% — outpacing both Walmart and Target. This growth is not nearly as affected by consumer sentiment as those other two or Amazon.

Its membership model lets it undercut almost everyone else on price. And if consumer confidence slips – or “ebbs” as Target’s Brain Cornell predicts – Costco’s core business will remain the least affected.

With the recent round of retail blowout performance on one side and the fear of an economic dip on the other, Costco should stand out from the rest. The retail industry is already up 11% so far this year. Costco has actually trailed that (up just 8% year-to-date). That means there’s room here for a short, post-earnings rally.

We have the perfect strategy to play it.

A Strategy For Short Term Bulls

A bull call spread is a type of trade that involves two call options, risk reduction and profit targets. For an options strategy, it is rather conservative… but can pack sizable short-term returns.

The way it works is by buying a near-the-money call option and selling a second one with a higher strike price. This reduces the cost of purchasing that first one.

The total trade remains a net debit spread. But the entry cost is far lower than simply buying a call option on its own… and often even the underlying shares outright. That entry cost is also the total amount at risk for this type of trade.


Source: The Options Industry Council

The profit potential for such a trade is capped, however. While shares can run higher and higher, and a call option can multiply those earnings without sight, this strategy has a maximum profit target. That’s not always bad however.

For Costco, in particular, we aren’t suggesting the company is about to somehow transform itself into a high-growth play overnight. No matter what earnings and forecasts it releases later this week, it is quite unlikely to see its shares double or triple in value.

So, this type of trade offers the perfect way to play this unique opportunity. But don’t take our word for it. You can see exactly what this trade can do by looking at a specific example…

A Specific Trade For Costco’s Earnings This Week

A trader looking to use this type of strategy on Costco could buy a March 15 $217.50 call for $5.67 per share and sell a March 15 $220 call for $4.14 per share for a net debit of $1.53 per share. That works out to $153 entry cost based on the 100 shares controlled by each call contract.

That’s the total amount at risk here. But again, this is less than either a call option outright or even a single share of Costco. And a nice return here is not hard to achieve.

To find the maximum profit potential for this trade, take the difference in strike prices ($220 – $217.50 = $2.50) and subtract the entry cost ($2.50 – $1.53 = $0.97). Because each contract is worth 100 shares, that’s a total pocketable return of $97 in just one and a half weeks.

Now, even though the risk outweighs the return, consider this… a $97 return represents a 10-day 63.4% return on the amount at risk. And it wouldn’t take a large amount of movement from Costco’s underlying shares to achieve that.

Right now, shares are trading at $219.80. That means they only have to go up 20 cents to reach this full maximum profit. Think about that. 20 cents on a $219.80 stock is so small, its negligible… barely more than 0%. With predicted strong earnings in two days, you could be looking at an easy 63% return in next to no time.

— The Option Specialist

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About the Author: The Option Specialist