Costco Just Got Crushed on Earnings and Mike Butler Immediately Bought It for $425

Key Concepts

• Calendar Spread: An options strategy involving the simultaneous purchase and sale of two options of the same strike price but with different expiration dates.
• Implied Volatility (IV): A metric that captures the market's view of the likelihood of movement in a security's price.
• Bollinger Bands: A technical analysis tool used to define high and low price levels relative to previous trades.
• Extrinsic Value: The portion of an option's premium that is not intrinsic value, influenced by time remaining until expiration and volatility.
• Cost Basis Reduction: The process of lowering the net cost of a trade by collecting premiums from short options.

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1. Market Context and Costco Earnings Analysis

Costco (COST) recently released earnings that underperformed market expectations. Despite the stock trading near $1,000, the market had priced in an expected move of less than 3% (30 points). Costco subsequently dropped 45 points (approximately 4.5%) to $950, moving outside the expected range. This decline marks an eight-day selling streak, bringing the stock back to price levels not seen since early February.

The speaker argues that Costco remains a defensive play in an inflationary environment. With crude oil prices projected to remain elevated between $80–$90 per barrel, inflationary pressures are expected to persist. Costco is positioned as a "value" retailer, similar to Walmart or Target, which typically sees increased consumer interest when cost-of-living pressures rise.

2. Technical Setup and Strategy

The speaker identifies that Costco has reached the lower Bollinger Band, suggesting an oversold condition. To capitalize on a potential bounce back to the $1,000–$1,050 range, the speaker initiated a Calendar Spread:

• Long Position: September 1,100 strike call.
• Short Position: August 1,100 strike call.
• Execution: The trade was filled for a $425 debit.

3. Strategic Methodology and Rationale

The primary goal of this trade is to benefit from a mean reversion (a bounce) in the stock price while maintaining a low-cost entry.

• Time Horizon: By buying the September cycle (approx. 100 days out) and selling the August cycle (approx. 80 days out), the trader minimizes the initial debit.
• Earnings Management: The next earnings announcement is anticipated for late August or early September. If the announcement occurs before the September 18th expiration, the long September option will retain significant extrinsic value.
• Rolling Strategy: The trader plans to roll the short August option into the earnings cycle. This allows the trader to collect additional premium, effectively reducing the cost basis of the overall trade.
• Risk/Reward: The trade is designed to be low-risk due to the low debit. If the stock price recovers to $1,000 or $1,050, the trader projects a return on debit exceeding 100%.

4. Key Arguments

• Buying the Dip: The speaker emphasizes that while tech stocks have been rallying, Costco has been aggressively sold, creating a favorable risk-to-reward entry point.
• Volatility Management: The strategy relies on the "volatility spike" associated with earnings. By holding the longer-dated option through the earnings announcement, the trader captures the value associated with that increased volatility.
• Cost Efficiency: The calendar spread structure allows for a wide range of opportunity with a relatively small capital outlay ($425), providing a "cheap" way to play a long-term recovery.

5. Synthesis and Conclusion

The trade is a tactical, long-term "buy the dip" approach on Costco, utilizing a calendar spread to manage time decay and volatility. The strategy hinges on two main outcomes: a price recovery to the $1,000–$1,050 level or the ability to roll the short leg of the spread into the upcoming earnings cycle to further reduce the cost basis. By leveraging the difference in expiration dates, the trader maintains a low-cost position that benefits from both potential price appreciation and the strategic management of extrinsic value during the next earnings announcement.