Is Costco the Perfect Stock for Writing Covered Calls?
When it comes to long-term investments, Costco has become a favorite among many investors due to its consistent performance. Recently, the stock has been showing signs of breaking out once again, prompting a discussion on whether it's the right time to write covered calls on this chugger of a stock. This post will explore the fundamentals of Costco, the concept of writing covered calls, and whether now is the ideal time to implement this strategy.
Understanding Costco's Performance
Costco has been a strong performer in the stock market, consistently delivering solid returns for its investors. The company is known for its robust fundamentals, including low debt and high return on equity. Costco's earnings per share (EPS) growth, though not explosive, is steady, reflecting the company's ability to generate profits consistently. This is characteristic of a "chugger" stock—one that steadily moves upward, with occasional corrections.
In the past few years, Costco has seen its stock price rise significantly, from around $400 to nearly $900. This growth can be attributed to the company's strong financial health and the strategic investments it has made. Investors who have held onto the stock have seen impressive returns, and with the stock poised to break out again, there's potential for further growth.
What Are Covered Calls?
Before diving into whether you should write covered calls on Costco, it's important to understand what covered calls are. A covered call is an options strategy where an investor holds a long position in a stock and sells call options on that same stock. The goal is to generate income from the premium received from selling the call option, while still holding onto the underlying stock.
This strategy works best with stocks that are stable or slowly appreciating, making Costco an ideal candidate. Since Costco tends to "chug" along—steadily moving up with occasional pauses—writing covered calls can be a great way to generate additional income without needing to sell the stock.
Is Now the Right Time?
Given Costco's current setup, with the stock forming a base around $897 and potentially breaking out, it might be an opportune moment to consider writing covered calls. If the stock does break out and move towards the $1,000 or even $1,150 mark, writing covered calls could provide you with a steady stream of income as the stock appreciates.
However, there are some risks to consider. If the stock breaks below its moving averages—particularly the 40-week moving average—this could signal trouble, and it might be a good time to reassess your position. But as long as Costco continues to perform well, writing covered calls could be a profitable strategy.
Life-Improving Tips: Managing Risk with Covered Calls
- Monitor the Moving Averages: Keep an eye on Costco's 10-week and 40-week moving averages. If the stock consistently trades below these levels, it may be time to reconsider holding or writing covered calls.
- Set Realistic Targets: When writing covered calls, set strike prices that align with your long-term goals for the stock. This ensures you're comfortable with the possibility of having your stock called away.
- Diversify Your Strategy: Consider using the covered call strategy on multiple stocks to spread risk. This way, you're not overly dependent on the performance of a single stock.
FAQs
- What happens if Costco's stock price exceeds the strike price of the covered call?
If the stock price exceeds the strike price at expiration, your shares may be called away, meaning you'll sell them at the strike price. While you'll miss out on any gains beyond that price, you still keep the premium received from selling the call.
- Can I still collect dividends if I write covered calls on Costco?
Yes, as long as you hold the stock through the ex-dividend date, you'll still be entitled to receive dividends.
- Is writing covered calls on Costco risky?
Like any investment strategy, there are risks. The primary risk is that the stock could decline in value, potentially offsetting the income generated from the call premiums. However, the risk is somewhat mitigated by the stable nature of Costco's stock.
Call to Action
If you're interested in learning more about writing covered calls and how to implement this strategy effectively, there are many resources available online, including tutorials and courses. Consider taking the time to educate yourself on this strategy, especially if you're holding a stock like Costco that is well-suited to this approach.
Conclusion
Costco's consistent performance and potential for further growth make it an attractive candidate for writing covered calls. By implementing this strategy, you can generate additional income while holding onto a solid, long-term investment. As with any investment strategy, it's important to monitor your positions and adjust as necessary, but with Costco, you might find covered calls to be a rewarding approach.
