May 12 2014, 11:25am CDT | by Forbes
Consistently, one of the more popular stocks people enter into their stock options watchlist at Stock Options Channel is Costco Wholesale Corp (NASD: COST). So this week we highlight one interesting put contract, and one interesting call contract, from the June expiration for COST.
The put contract our YieldBoost algorithm identified as particularly interesting, is at the $114 strike, which has a bid at the time of this writing of $1.51. Collecting that bid as the premium represents a 1.3% return against the $114 commitment, or a 10.5% annualized rate of return (at Stock Options Channel we call this the YieldBoost).
Selling a put does not give an investor access to COST’s upside potential the way owning shares would, because the put seller only ends up owning shares in the scenario where the contract is exercised. So unless Costco Wholesale Corp sees its shares fall 2.2% and the contract is exercised (resulting in a cost basis of $112.49 per share before broker commissions, subtracting the $1.51 from $114), the only upside to the put seller is from collecting that premium for the 10.5% annualized rate of return.
Interestingly, that annualized 10.5% figure actually exceeds the 1.2% annualized dividend paid by Costco Wholesale Corp by 9.3%, based on the current share price of $116.55. And yet, if an investor was to buy the stock at the going market price in order to collect the dividend, there is greater downside because the stock would have to lose 2.19% to reach the $114 strike price.
Always important when discussing dividends is the fact that, in general, dividend amounts are not always predictable and tend to follow the ups and downs of profitability at each company. In the case of Costco Wholesale Corp, looking at the dividend history chart for COST below can help in judging whether the most recent dividend is likely to continue, and in turn whether it is a reasonable expectation to expect a 1.2% annualized dividend yield.
Turning to the other side of the option chain, we highlight one call contract of particular interest for the June expiration, for shareholders of Costco Wholesale Corp (NASD: COST) looking to boost their income beyond the stock’s 1.2% annualized dividend yield. Selling the covered call at the $118 strike and collecting the premium based on the $1.59 bid, annualizes to an additional 10.8% rate of return against the current stock price (this is what we at Stock Options Channel refer to as the YieldBoost), for a total of 12% annualized rate in the scenario where the stock is not called away. Any upside above $118 would be lost if the stock rises there and is called away, but COST shares would have to climb 1.2% from current levels for that to happen, meaning that in the scenario where the stock is called, the shareholder has earned a 2.6% return from this trading level, in addition to any dividends collected before the stock was called.
The chart below shows the trailing twelve month trading history for Costco Wholesale Corp, highlighting in green where the $114 strike is located relative to that history, and highlighting the $118 strike in red:
The chart above, and the stock’s historical volatility, can be a helpful guide in combination with fundamental analysis to judge whether selling the June put or call options highlighted in this article deliver a rate of return that represents good reward for the risks. We calculate the trailing twelve month volatility for Costco Wholesale Corp (considering the last 251 trading day COST historical stock prices using closing values, as well as today’s price of $116.55) to be 15%.
In mid-afternoon trading on Monday, the put volume among S&P 500 components was 651,182 contracts, with call volume at 1.19M, for a put:call ratio of 0.55 so far for the day. Compared to the long-term median put:call ratio of .65, that represents very high call volume relative to puts; in other words, buyers are preferring calls in options trading so far today.
Find out which 15 call and put options traders are talking about today./>
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