Walt Disney Co (NYSE:DIS) reported earnings and markets reacted to the downside before bidding shares back up this morning. And while the company cited seriously challenges, I believe those challenges are external and do not stem from bungled executions within the company.
My last trade on Disney stock was a huge win. I shorted DIS for free and it worked out perfectly. I sold longer-dated puts to buy shorter dated puts. Today I want to simply generate income from the price action in DIS stock.
Fundamentally, I think that DIS will be able to ride out the current wrinkles in its TV businesses. Management seems committed to adjust their models to fit the new streaming demands. And technically, I see clear areas of support from 2015 sell offs. Disney’s last two corrections were huge, but they came after sharp rallies.
This time, the initial negative reaction came from a period of sideways price action. This usually establishes a base from which they can bounce back. DIS stock is not too cheap, so it could still fall a bit. That said, I need to set a buffer to my trade. Analyst ratings are mostly holds, so there’s no obvious danger from major downgrades.
I’m left worrying mostly about the stock market in general, however. Markets have never been higher. The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) is at an all-time-highs on deteriorating global fundamentals. This creates an unusual situation that could end ugly. If markets in general correct, then DIS stock will also suffer. I will need to closely manage the risk of loss.
The options market offers me hundreds of ways I can implement any strategy. Selling puts is dangerous and I only do it when I am willing and able to buy the stock at the strike sold. So typically I only do this in stocks where I believe in the company current value and the short term worst case scenario of its value.
Disney Stock Options
Trade #1: Sell the DIS Jan $80 put. This is a bullish trade for which I collect $1 per contract. Ideally, I need DIS stock to stay above $80 per share through 2016. This leaves me with a 16% buffer from current price. If DIS falls below $80 in the next few months, I could be assigned the stock at $80 per share and accrue losses thereafter.
Selling naked puts requires margin and somewhat open risk to the downside. I can modify the trade to suit a smaller risk appetite.
Trade #2 – An Alternative: Sell the Disney stock Jan $82.50/$80 credit put spread. This is also a bullish trade for which I collect 30 cents per contract. Theoretically, this trade has a 90% chance of success and can yield 15% on the money at risk. Ideally, I need DIS shares to stay above $82.50 per share to be completely successful.
Someone who expects Disney to rally can use the proceeds to buy DIS calls. This would make them long the stock for free, which means the puts sold would pay for the upside potential of a rally.
I am not obliged to hold the trades through their expiration dates either. I can close any trade at any time for partial gains or losses by simply reversing the process.
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. You can follow him on Twitter at @racernic and stocktwits at @racernic.