Walt Disney Co (NYSE:DIS) stock fell 2.7% on Tuesday after a five day 10% rally. So a small give-back is normal. The spike came from a mix of headlines of buyout talks with Twenty-First Century Fox Inc (NASDAQ:FOXA) and a technical breakout that triggered above $106 per share.
DIS will soon release its next Star Wars episode, and I bet it will do very well at the box office … but that has rarely been a trigger for a higher stock price. So chasing it here by buying Disney stock outright has a high chance of failure. Instead, I will set a bullish trade using options that needs no rally to profit.
Fundamentally, DIS is not expensive even though it’s a three-digit stock — stock price tag is not the same as value.
I do admit that its stock has run too far too fast, but I still see tangible value, and therein lies my opportunity. DIS trades with a 19 price-to-earnings ratio so it’s not bloated by any means. This is about the same as the value in Apple Inc. (NASDAQ:AAPL) so it’s in good company.
DIS management is proven to be reliable and rarely gives Wall Street many reasons to sell the stock. Nevertheless, traders love to sell it and for no reason; hence the need for a buffer zone on my trades. Since I’ve seen DIS stock fall 10% or more even on good news, I never risk my money without plenty of room for error.
When selling premium, I want nothing to happen, so headlines are the enemy. While the talks with FOXA are ongoing, DIS is now prone to major headlines. They are looking to acquire great assets including stakes in HULU but I am sure that it will carry a high cost. So I must accept the risk of a DIS stock shock selloff on the news.
Regardless of the short-term knee-jerk reactions, eventually investors will buy it based on its fundamentals. So I am confident that if I have to own shares at a discount from here, I will be able to manage out of my risk for a profit.
Experts on Wall Street are in a holding pattern on DIS stock, and it now trades close to the average analyst price target. I don’t expect any of them to downgrade DIS into year end especially not knowing the outcome of the negotiations with FOXA.
I am also anticipating good things to come many months from now when the DIS streaming service nears its live date. Given the success of Netflix, Inc. (NASDAQ:NFLX), I bet that DIS’s service will take off like a rocket.
Parents will agree with me when I say that the kids will force most households to subscribe to it. With streaming data becoming so cheap on our cell phones, parents will then have a tag-along baby sitter anywhere they have cell service or wi-fi. That is a lure too tempting to pass up.
The Trade: Sell the DIS Jun 2018 $90 naked put and collect $1.25 to open. Here I have an 85% theoretical chance to retain maximum gains. But if the price falls below my strike then I own it an would accrue losses below $88.75.
Selling naked puts is daunting, especially near all-time-high stock markets. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell DIS Jun 2018 $90/$87.50 credit put spread. The spread has the same odds but would deliver 10% yield on risk. Neither trade require a rally to profit.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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 as @racernic on twitter and stocktwits.