Zoom Video (ZM), Target (TGT), Costco (COST) and several other highly liquid stocks are due to announce next week.
I use the weekly table above as a guide to what I want to focus on in the week ahead. It provides me with some simple but important implied volatility readings along with the average move after earnings, which gives me great insight into how I will approach my strategy of choice (which strikes to use, etc.).
As I’ve stated in the past, I hope that by going through a few examples of various options strategies every earnings season we can start to build a solid foundation on how to appropriately apply options selling strategies with a focus on high-probability trades.
Today I’m going to focus on Costco (COST).
The company is due to announce after the closing bell on March 3. I’m going to go through a risk-defined strategy and an undefined risk strategy taking a high-probability approach. I hope this continues to be a helpful exercise for not only trading around earnings, but for also using similar strategies using various timeframes (expiration cycles).
Here is how Costco has performed immediately following earnings dating all the way back to December 12, 2006.
Image courtesy of Slope of Hope
As you can see, Costco has a history of being quite volatile from time to time after earnings. But that’s okay, it’s always good to see what a trade is offering us, particularly one that might seem a bit more aggressive given Costco’s history around earnings. But if the premium and probabilities make sense, well, we might have a nice opportunity at hand.
Let’s take a closer look.
Iron Condor Earnings Trade in Costco (COST)
Costco (COST) is due to announce after the close next Thursday. So, let’s take a look at a potential trade using a risk-defined options strategy like an iron condor.
The stock is currently trading for 505.58.
The next item is to look at Costco’s expected move for the expiration cycle that I’m interested in.
The expected move or expected range over the next eight days can be seen in the pale orange colored bar below. The expected move is from 482 to roughly 528, for a range of $46.
Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my iron condor outside of the expected range, in this case outside of 482 to 528.
This is my preference most of the time when using iron condors.
If we look at the call side of COST below for the March 4, 2022, expiration, we can see that the 532.5 call strike offers an 84.35% probability of success and the 537.5 strike offers us a 88.00% probability of success. For this example, I’m going to sell the short call at the 532.5 call strike and define my risk with the 537.5 call strike. By choosing the 537.5 call strike to define my risk, I know that there is less than an 11% chance that COST will close above the 537.5 strike at expiration.
Now let us move to the put side.
Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 482. The 460 put strike, with an 87.26% probability of success, works as our short put strike. I’m going to stick with a 5-wide spread on the put side as well so the 455 will define our probability of success on the downside. The 455 put strike has an 89.27% probability of success. This means there is less than a 11% chance of taking a max loss on the trade.
We can create a trade with a nice probability of success if Costco stays between our 72.5-point range, or between the 532.5 call strike and the 460 put strike. Our probability of success on the trade is 84.35% on the upside and 87.26% on the downside.
I like those odds. But do I like them enough to take the trade?
Here is the trade:
Sell to open COST March 4, 2022, 532.5 calls
Buy to open COST March 4, 2022, 537.5 calls
Sell to open COST March 4, 2022, 460 puts
Buy to open COST March 4, 2022, 455 for roughly $1.00 or $100 per iron condor
Our margin requirement is $400 per iron condor.
Return on the trade is 25.0%.
Again, the goal of selling the COST iron condor is to have the underlying stock stay below the 532.5 call strike and above the 460 put strike immediately after COST earnings are announced.
Here are the parameters for this trade:
- The Probability of Success – 84.35% (call side) and 87.26% (put side)
- The maximum return on the trade is the credit of $1.00, or $100 per iron condor; that’s a 25.0% return per iron condor
- Break-even level: 533.5 – 459
- The maximum loss on the trade is $400 per iron condor. We always adjust if necessary, and always stick to our stop-loss guidelines. Position size, as always, is key.
But before I pull the trigger, let’s take a look what our margin of error is on the upside and downside.
With Costco currently trading for roughly 505.58, our short 532.5 call strike is roughly 27 points away for a 5.34% margin of error.
On the downside, our short 460 put strike is roughly 65 points away, for a 12.87% margin of error.
As for Costco’s current IV rank?
Take a quick look at the chart above and you can clearly see we are experiencing some of the best premium in years.
Nonetheless, a trade in Costco, particularly with the recent market price action, is not for the faint of heart. But with a pegged IV rank, good premium and an opportunity for a high-probability trade with a nice margin of error Costco will be tops on my watchlist heading into next week.
Remember, I prefer to make these trades the day before earnings are announced, so I would expect to see the premium a bit lower than it is now due to decay. So, premium could be an issue at the time of the trade. But I like to see where potential trades stand the week prior, so I have a good understanding what stocks look appealing for a potential trade around earnings, which is why I go through this exercise with the stocks on my weekly earnings watch list.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.