Costco; The Best Things to Buy at Costco: Options

Costco Wholesale, seller of giant cans of tuna fish and massive tubs of detergent, is trading like Twitter in the options market.

Investors are paying top-dollar to buy Costco (ticker: COST) calls as the stock pushes to new highs. Twitter (TWTR), which went public Thursday, should be so lucky to attract as much bullish call trading when its options are listed Nov. 15.

The interest in Costco was sparked by better-than-expected October same-store sales. Sales rose 3%, beating the 2.6% expectation. A lot of money was wagered on the report.

On Wednesday, investors traded more than 19,100 Costco calls, more than double Costco's usual options market volume. The November $125 calls were, and remain, the hot Costco trade. With the stock around $123, investors are maintaining those positions in anticipation the stock pushes forward into record territory.

If there is one caution signal flashing in the options market it is the absence of a continued bullish follow-through. That the calls are pegged to the same-store-sales report suggests investors are treating Costco like an event-driven trading opportunity, rather than as a fundamental investment.

The options trading pattern, while unusually strong, suggests positioning for Costco to decline. But the recent strong report, coupled with positive fundamentals, makes it hard not to want to own shares into earnings and another same-stores-sales report.

Rather than just buying puts that would increase in value if the stock pushes lower, consider selling January $123 puts for $3.25 and buying the January $125 call for $2.29 (options priced when Costco traded at $123.23).

Costco trades at 22 times forward earnings, which is not unreasonable for a company that is growing sales and paying a slight 1% dividend. The company is scheduled to report earnings Dec. 11.

If the stock rallies higher, the January $125 call will increase in value. At $130, the call is worth $5. Should the advance occur, the money for selling the put can be kept. Under this best of all possible scenarios, the options market will have paid investors 96 cents to bullishly speculate on Costco's advance.

If the stock declines below the put strike price, investors are obligated to buy the stock, which should not hurt given that Costco is one of those places people walk into planning to buy toilet paper and walk out of $500 lighter.