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Thank You, Costco

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Thank You, Costco

Thursday, 11 October 2007

By Chris Johnson
I’ve made it rather clear over the past few weeks that I love earnings season. It creates expectations, it moves sentiment to extremes, it gets stocks moving, it gets the adrenaline flowing … in short, it opens up opportunities.
And it’s fun. Especially when you start off with a winner.

That’s what happened this week with Costco (COST), a stock/option play we recommended in our Earnings Tip Sheet. The stock reported earnings yesterday that beat the Street by 10 percent. The stock popped more than nine percent on the news, allowing subscribers to collect up to 90 percent or so on their call option.

So how did we analyze COST? Sentiment, sentiment, sentiment.

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The technicals were showing some strength, although I was concerned that the stock was pushing the top of a trading range and could form a peak as it did in August.

The trade was based on pessimistic sentiment, the thought process being that anything exceeding expectations would cause 1) pessimism to unwind, and 2) the stock to break above the August peak.

Where was I seeing this pessimism? First, in a put/call ratio that was descending off a peak, meaning that buyers were starting to pick up the pace relative to sellers heading into earnings. Second, short interest had been increasing, adding to the chances of a short-covering rally. Third, seven of 12 covering analysts rated the shares a “hold,” leaving plenty of room for upgrades.

This trade underscores the importance of sentiment during earnings season. Sure, COST had a nice earnings report, especially considering all the downgrades we’ve been seeing of late. But sentiment provided that extra fuel that pushed the stock above technical resistance.
I look forward to many more such trades this earnings season.
Source : Investor's Daily Edge

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