Investors sent shares of Adobe (ADBE) sharply lower Thursday after the company offered up soft revenue guidance. Wall Street will be hoping for a different tune from retail stocks like Costco (COST) and Darden Restaurants (DRI) ahead of upcoming earnings reports.
Despite strong fundamentals, Costco stock has been under selling pressure as it tries to hold the 500 level.
Costco has a Composite Rating of 85, helped in part by high return on equity and several quarters in a row of double-digit revenue growth. Costco stock also has a Relative Strength Rating of 83 from IBD Stock Checkup, ranking it No. 2 in its group.
Results from Darden Restaurants — the parent company of Olive Garden, LongHorn Steakhouse and Yard House — are due Thursday before the open. The Zacks consensus estimate is for adjusted profit of $1.56 a share, down 11% from the year-ago quarter. Look for revenue to be up 7% to $2.37 billion.
DRI stock looks a little better than Costco stock as it consolidates near its 40-week moving average. Darden’s relative strength line has started to trend higher after a nice rally off lows, but the 40-week line is still a potential resistance level after Darden got turned away at the line last month and wrestles with it now.
Costco Stock Fades Ahead Of Results
Results from Costco are due Thursday after the close. Adjusted profit is expected to rise 5% to $4.11 a share, with revenue up 15% to $71.84 billion.
Late last month, Costco reported August sales of $17.55 billion, up 11% from a year ago. Same-store sales increased 8.7% for the month.
Costco stock responded positively when the company reported earnings in late May. Shares jumped nearly 6% in big volume even though margins took a hit due to rising freight and labor costs. Earnings and revenue came in better than expected, with adjusted profit up 2% to $2.91 a share. Revenue increased 16% to $52.6 billion. Total company same-store sales jumped an impressive 14.9%. On an adjusted basis, same-store sales increased 10.8%.
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Despite strong fundamentals, Costco stock has been struggling to attract buyers after a short-lived breakout over a 552.81 buy point. Costco quickly paid a visit to its 200-day moving average, rallied back above the line for four sessions, then gave up the support level Tuesday in heavy volume.
FedEx (FDX) also reports Thursday after the close. The package delivery giant poked above its 40-week moving average in June when it last reported earnings. But sellers hit the stock hard Friday after the company guided earnings and revenue below expectations and pulled its outlook. CEO Raj Subramaniam said he expects the economy to enter a “worldwide recession.”
In the oil and gas sector, Ovintiv (OVV) reports early Monday. It’s forming a cup-with-handle base with a 56.41 entry.
Elsewhere, FactSet Research Systems (FDS) reports early Thursday. It’s still trading near a 448.69 double-bottom entry, but an alternate handle buy point of 457.09 is also valid.
Options Trading Strategy
A basic options trading strategy around earnings using call options allows you to buy a stock at a predetermined price without taking a lot of risk. Here’s how the options trading strategy works.
First, identify top-rated stocks with a bullish chart. Some might be setting up in sound early-stage bases. Others might already have broken out and are getting support at their 10-week lines for the first time. Some might be trading tightly near highs and refusing to give up much ground. Costco stock is still far off highs, but another quarter of strong revenue growth could fuel another round of buying. Avoid extended stocks that are too far past proper entry points.
In options trading, a call option is a bullish bet on a stock. Put options are bearish bets. One call option contract gives the holder the right to buy 100 shares of a stock at a specified price, known as the strike price.
Put options are for weak performers with bearish charts. The only difference is that an out-of-the-money strike price is just below the underlying stock price. A put option gives the holder the right to sell 100 shares of a stock at a specified price. You earn profits when the stock falls below the strike price with a put option.
Check Strike Prices
Once you’ve identified an earnings setup for a call option, like FedEx stock, check strike prices with your online trading platform or at cboe.com. Make sure the option is liquid, with a relatively tight spread between the bid and ask. Look for a strike price just above the underlying stock price (out of the money) and check the premium. The premium ideally should not exceed 4% of the underlying stock price at the time. In some cases, an in-the-money strike price is OK as long as the premium isn’t too expensive.
Choose an expiration date that fits your risk objective. But keep in mind that time is money in the options market. Near-term expiration dates will have cheaper premiums than those further out. Buying time in the options market comes at a higher cost.
This options trading strategy lets you capitalize on a bullish earnings report without taking too much risk. Risk is equal to the cost of the option. If the stock gaps down on earnings, the most that can be lost is the amount paid for the contract.
Costco Stock Option Trade
When Costco closed Thursday at 503.50, a slightly out-of-the-money weekly call option with a 505 strike price (Sept. 30 expiration) came with a premium of around $13.80, or 2.7% of the underlying stock price at the time.
One contract gave the holder the right to buy 100 shares of Costco stock at 505 per share. The most that could be lost was $1,380 — the amount paid for the 100-share contract.
When taking the premium paid into account, Costco would have to rally past 518.80 for the trade to start making money (505 strike price plus $13.80 premium per contract).
Keep in mind that this is not a trade for a smaller portfolio. Buying 100 shares of Costco stock would cost $50,50o.
Follow Ken Shreve on Twitter @IBD_KShreve for more stock market analysis and insight
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