Costco (COST) - Option Trader Plays Earnings Via the Ratio Put Spread

Costco (COST) options were active ahead of earnings to be reported before the open tomorrow morning, call volume 4X daily average and put volume near 4X daily average. There were a couple large trades on the day, early in the day the March $75/$80 "Call Stupid" Spreads traded around 2,500 contracts, both legs pricing below the bid. The March $75 calls traded 5,401 and $80's traded 3,483 on the day, well exceeding open interest, fresh action that pushed March IV 12% higher. Also, back on February 22nd a block of 20,000 March $70 puts was rolled out to the July $70 puts, which remain in Open Interest.

Costco shares are now trading in a tight $73 to $75 range after finally breaking clear of the 2008 top. The $32B retailer trades 19.4X earnings, 0.4X sales and 21.17X cash flow, and should be boosted from gasoline sales. Costco is a superb operator and generally reacts well on earnings, but after recently topping out at $75 is could pull back to the 50 day EMA at $72.42 where it tends to bounce, but expect buyers to bring it back from that level. Shares made a bearish ADX cross on 2/25 and the downtrend does have potential to accelerate from here.

This brings me to the ratio put spread that traded today at 2:14pm on the CBOE. The trader bought the March $75/$72.50 1X2 ratio put spread for 1,500X3,000 contracts at a $0.05 debit. The trade is bearish volatility, but actually positive Delta (Delta 0.14), as the $75's will hold value if shares head higher while the $72.50's will rapidly lose value, and the spread will widen. The trader makes maximum profits with shares sitting on the $72.50 level come options expiration, and is profitable in the $70 to $74.95 range come expiration, although the trader would likely exit the trade early if the shares hang in the $75 range next week, the trade a positive Theta trade as well. The trade comes with Costco's IV at more than a 6 month high, which ran up 40% in the past 3 weeks. With a small $0.05 outlay the trader can bank big time percentage gains on this trade, and it is fairly low risk, only getting the trade in trouble if shares were smashed below $70, which seems unlikely for a well respected name trading at fair valuation. (The P/L View is Below Using ThinkorSwim's Analyze Function)



My chart of CostCo is Below along with IV, HV, ATR Wilder, CCI, and Relative Volatility Index (This Likely Looks Confusing, but Settings I Have Gotten Used To)




Time will tell if this trade works or not, but as long as it hangs in this $70 to $75 range, it should work well, and looks to be a great choice into earnings. Also note, ratio spreads like these are often hedging large equity positions, because you get more "bang for your buck" with this type of hedge into a stock-moving catalyst.