News of Amazon.com, Inc.‘s (NASDAQ:AMZN) purchase of Whole Foods Market (NASDAQ:WFM) has captured the fascination of traders everywhere, but also the ire of anyone holding onto Costco Wholesale Corporation (NASDAQ:COST). COST stock took a clobbering on Friday — one that has traders licking their lips at potential trade setups.
The implications of a juggernaut like AMZN entering the grocery marketplace are myriad. Fear and trepidation seized any and all companies now vulnerable to Amazon’s market share stealing ways. Chief among the losers were Kroger Co (NYSE:KR), Wal-Mart Stores Inc (NYSE:WMT), Target Corporation (NYSE:TGT) and, of course, Costco.
But it’s COST stock that I find the most interesting here.
Before Friday’s surprise plunge, Costco shares were flirting with record highs. Indeed, the membership-only warehouse club known for its bulk discounts had risen 17.6% year-to-date, taking full advantage of continued optimism surrounding the aging bull market.
Now, a dark cloud hangs over the stock.
COST actually suffered a double-whammy on Friday. In addition to the Amazon acquisition news, the company received a downgrade from Goldman Sachs. As you might assume, the latter was a direct result of the former. Citing elevated competition from Amazon, Goldman modified its rating on the company from buy to neutral.
What makes COST stock standout from the other grocers/retailers mentioned earlier (KR, WMT, TGT) was its inability to recover from the initial freefall on Friday morning. The stock limped into the close while the rest of the group rallied back strong.
To provide context for Friday’s drubbing, let’s survey both the weekly and daily charts.
The downturn was serious enough to shatter the first potential support level on the weekly chart ($169). For the short-term trend to remain pointing higher, this zone should have held. It’s failure signals the trend is now in jeopardy.
Click to Enlarge Source: OptionsAnalytix
Watch the $164 level moving forward. The next pivot low and the 50-week moving average rest in this area so it should be considered a potential support level.
On the momentum front, it’s worth noting COST did flash a warning sign that was confirmed with Friday’s drop. This cautionary signal came in the form of a divergence in the RSI indicator.
The daily chart reveals the potential support area of $164 in greater detail.
Multiple pivots have formed in this area. The rising 200-day moving average also rests close. Not surprisingly the RSI indicator on the daily dropped to its lowest level since last November confirming the stock has indeed become oversold. A 7% one-day drop will do that to you.
Click to Enlarge Source: OptionsAnalytix
In sum, the break of weekly support makes rallies in the stock suspect. That means we want to be sellers at higher prices. But at the same time, the oversold conditions on the daily chart make it likely the stock will snap-back if it stretches much further to the downside. And that means we want to be buyers at lower prices.
How to Trade COST Stock From Here
The final piece to this puzzle is the pricing of options. The Friday surprise delivered a dash for protection that sent option premiums to the moon. Costco’s implied volatility rank rocketed from near zero to 68%.
And that, friends, is making it mighty attractive to sell options here.
If you couple our directional bias (wanting to be short at higher prices, but long at lower prices) with the expensive options, it creates a perfect opportunity for an iron condor play.
Sell the Jul $153/$158/$175/$180 iron condor for $1.29 or better. The trade consists of selling the Jul $153/$158 bull put spread and the Jul $175/$180 bear call spread. To capture the max profit of $1.29, COST stock needs to settle between $158 and $175 at expiration.
The max loss is $3.71 and will be lost if Costco sits below $153 or above $180 at expiration.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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