Traders make bullish bets on Costco, but downside risks may be brewing

Betting on Costco could cost you, according to one expert.

The wholesale giant’s stock got a wave of bullish bets in Wednesday’s trading session as options traders put money on their positive outlook for the company’s earnings report, scheduled for after Thursday’s closing bell.

Call option activity — bets that the stock would go higher in the near term — outpaced put option buying by double, indicating that more traders believed that Costco’s 5% implied move after earnings would be to the upside than to the downside.

“Obviously, the stock has been a massive outperformer. It’s up 40% on the year,” Dan Nathan, co-founder and editor of RiskReversal.com, said Wednesday on CNBC’s “Options Action.”

“The company’s doing really well, expected to post 14% year-over-year earnings growth this year,” Nathan said. “But [that’s] set to decelerate next year.”

With Costco currently trading at a price-to-earnings multiple of about 37 times, that’s clearly not what investors are expecting — but Costco’s chart seemed to back up Nathan’s call.

“It’s obviously held that uptrend from the December lows very, very nicely, but interestingly enough, it’s come back to that uptrend and it’s also come back to the level where it broke out in August,” Nathan said. “When it broke out at that [$]250 level, … it went up 20%.”

That may be a sign that Costco has come too far too quickly, and its rivals in the space seem to be following suit, Nathan said.

“There’s a lot of concentration in … Walmart, Costco and Target,” he said, adding that Costco’s accumulating risks — from its elevated multiple to its expected earnings-per-share deceleration — create the potential for “considerable downside.”

Tim Seymour, founder and chief investment officer of Seymour Asset Management, raised concerns in the same “Options Action” segment about what could happen to Costco if U.S. consumer strength peaked.

“If the consumer weakens, who’s in trouble?” he said. “If you look at big-box stores, they’ve been the biggest beneficiar[ies] of a stronger consumer and a job market that really has benefited that part of the labor force. … And if you look at the multiples that all these stocks [have], Costco has a more manageable valuation than some of the others, but relative to themselves … they’ve had such a big run based upon the strength of that consumer.”

Steve Grasso, managing director of institutional trading at Stuart Frankel, said that as big-box retail stocks stay strong, Costco could still climb.

“I do like it on a pullback and the international angle of growth there,” he said in the same “Options Action” segment. “They’re doing a little under [$]40 billion in revenue. I think that’s where you’re going to get the growth out of Costco for the next leg higher.”

Costco shares were up less than 1% by midday Thursday.

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