Walt Disney Co (DIS) reports earnings this week, and I feel like trying my luck at a directional trade on DIS stock.
Short-term reactions to earnings are always a coin flip; no one knows how the markets will react to the numbers, regardless of how strong they are. DIS could be the poster child for this, as it has seen some strong reversals on earnings in the past.
My strategy here is a pair trade with a bearish bias. And that’s not to say I’m bearish on Disney stock, I just want to game the short-term price action off earnings. Long-term, I love what Disney does and I love DIS stock.
I will use options for this trade setup, even though this week’s earnings inflate the premiums, so they will be expensive to buy. Level picking is a crucial part of a successful trade. Even if I guess the direction of the move correctly, I can still lose my premium if I don’t pick smart levels.
Here, I favor buying the options close to the money. To be successful, I only need to guess the direction. This is a true binary directional trade with almost a 50% chance of success — based solely on direction, and not the magnitude of any move in Disney shares.
Trade No. 1 – Short-term bearish bet on earnings: Buy the DIS May $105 put. This is a bearish trade for which I pay $1.83 per contract. This is my maximum potential loss. I stand to profit if DIS stock falls lower than the strike price in the next 11 days.
Trade N0. 2 – Long-term bullish bet on potential value: Sell the DIS Jan $85 put. This is a bullish trade for which I collect $2.11 per contract. This opens risk, as I am obliged to own DIS stock at $85 per share should it fall lower than that strike price this year.
Before you make trade No. 2, understand the risk of selling naked puts. If you don’t already own DIS stock, you should only sell puts if you’re willing and able to own Disney stock at that level. To me, owning shares at a 20% discount from current prices would be a welcome event — especially since I would have an even lower breakeven price thanks to the profits from the short-term puts.
Fundamentally, DIS is a well-managed company with very few fumbles; it has incredible assets and hordes of fans. So unless the markets in general severely correct this year, DIS stock should hold above $85.
Click to Enlarge Technically, DIS has enjoyed a nice bounce off the February lows. It also shows a potential spike to $116 per share. This would kill my trade here.
However, the net effect of the pair trade described here is a net credit, so I am getting paid a little to take a chance at profiting off a short-term earnings reaction.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
