Option Play for COST

• stevenplace
• May 26th, 2009

Nice multimonth breakout going on in COST right now. Check out the chart:

Very nice breakout over 48.5, there’s a lot of moving averages crossing and turning up; it’s currently tagging the upper Bollinger Band and the bands seem to be expanding. So from a technical standpoint there’s a lot of price and MA support underneath it and could have an positive expansion in price as well as volatility.

Two risks I see in this setup. First you’ve got the 200 DMA bearing down on price. Second is that there is earnings risk coming in the next few days. So what option strategies are prudent here?

Well, it’s going to depend on your own style and risk management. But after considering all the risks and options, here’s the play I’m looking at:

BUY +5 VERTICAL COST 100 JUL 09 50/55 CALL @1.58 LMT

Here’s some stats:

Delta: 148 | Gamma 9.62 | Vega 13.6 | Theta -4.85

Breakeven at Jul Expiry: 51.58

Prob of being above b/e price: 33.51%

Vertical Reward/Risk: 1710/790 -> 2.16

Implied Statistical Expectancy: 1710 * .3351 – 790 * (1 – .3351) = ~50 bucks

So why this trade? Well I didn’t want unlimited risk via selling puts going into earnings. Some people can do that but I won’t. And if I’m going to be an option buyer I don’t want to do front month as I want this to be a longer hold than a couple days.

Another point is that the implied volatility really isn’t that high going into earnings. Selling vol here just doesn’t make sense in terms of risk and reward (it’d be close enough to a put sale).

So I’m expecting that there won’t really be a vol crush going into earnings so I’m willing to take the vega risk.

Also notice the effective delta. I’m getting long virtually 150 shares here; to do so with just straight stock you would need about $7300, or 3650 on 2x margin. So with the overall debit being the only cash you need to put up, you’re ~4.5x leverage vs. margin. And with the limited risk, I’m willing to buy some insurance for that sort of exposure.

If we get a significant runup, I’d look to hedge the position via short stock or short synthetic or short calls — we’ll see if it’s a successful trade.

Do not that I haven’t entered in this trade yet; this is an idea for tomorrow, so price may be modified.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Tickers: cost

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