EDITOR’S NOTE: Sam Collins will return to the Daily Trader’s Alert later this week. Nicolas Chahine is providing today’s Trade of the Day. Thank you!
Going long a stock when markets are at all-time highs is a difficult thing to do. To make matters worse, Walt Disney Co (NYSE:DIS) is reporting earnings, so the short-term uncertainty for that stock is amplified.
I recently shared a long Disney options trade that delivered fast profits with zero out-of-pocket risk, even when the price action was less than ideal.
That’s why I prefer using options. I don’t need to be surgical with my entry points into fundamentally sound tickers. Since earnings events are binary in nature (for the short-term), it’s imperative that I use options to trade DIS stock from here.
Technically speaking, Disney shares have corrected more than 6% from the recent highs. Usually if investors are too worried about earnings, they delay buying the dip until after the event. But DIS buyers stepped in immediately and bounced the stock off the $109. This speaks to traders’ longer-term intentions.
Furthermore, $109 per share is a level that has been pivotal since April 2014, so neither side are likely to give it up without a fight.
If the bears succeed in taking DIS stock below $109, they could overshoot and retest $104, which could be the next battle zone. Conversely, the bulls have the opportunity to continue trading the ascending channel toward $115.
Fundamentally speaking, Disney’s valuation — at 20 times trailing earnings — is not outrageously expensive given the value of its assets and the quality of its execution. Furthermore, management rarely gives Wall Street reasons to push the sell button unprovoked. Moreover, analyst expectations are too humble, and if there were surprise changes in ratings, they are likely to be upgrades rather than downgrades.
Even so, instead of risking $112 per share buying Disney at face value without any room for error, we can use options to create income out of thin air. The idea? Sell risk below proven support levels and let time to do the heavy lifting.
How to Trade DIS Stock
The bet: Sell the Dec $90 put and collect $1 per contract. In theory, the 20% price buffer gives me a 90% chance that the share price will stay above my risk, thereby allowing me to keep my maximum gains.
Selling puts near all-time highs, regardless of the quality of the stock, is fraught with danger. However, I can sacrifice a few pennies buying temporary put insurance around $90 through July.
If I am unable or willing to own DIS stock, then I’d change this trade into a credit put spread to limit the maximum risk exposure. Even with a finite risk profile, the spread would still have the opportunity to yield 7% or more. Compare this with risking $112 per share and needing the stock to rally 7% to match the performance of the spread.
The advantage of selling downside risk is that I would still profit even if DIS stock stalls. All I need to profit is Disney’s price to stay above my sold risk.
E-mail firstname.lastname@example.org with questions or join me to learn more about options in a personal 1on1 webinar here. 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.