In prepared comments to Congress this morning, Fed Chair Janet Yellen opined on equity valuations, specifically in certain sectors:
“…Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year”
This caught me off guard. While what Ms. Yellen said is not exactly news to us pros, the mention of equity valuations strikes me as possibly a CYA in case things get really out of hand as a result of the Fed’s continued dovish stance. Interesting.
But I would argue that it is not just small caps or speculative social media stocks with valuation issues here. Some large media stocks like Disney (DIS) also fit the bill. Disney sports an almost $150 billion market cap and is trading at 22x this year’s and 18.5x next year’s expected earnings. Earnings next year are expected to grow at only 10% with sales growth of 6%. Current PE sits at a 7 year high:
There was some large options activity in DIS today that caught my eye. This morning when the stock was $86 an investor sold 50,000 of the Jan15 95 calls at 1.44 to close. What’s interesting about this is that these calls were bought to open about 40 days ago (on June 4th) for 1.66 when the stock was $84. We obviously have no idea what the intent of this investor was, but I think it is a safe bet that they expected the stock to go higher.
The question I would have is if the investor originally was looking out to Jan15 expiration to give the thesis some time to play out, then why close for a loss after a little more than a month with the stock having appreciated since the trade entry? We can only speculate, but the entry at $84, and the exit at $86 in less than a month and half netting a loss of .22 on 50,000 contracts, or $1.1 million demonstrates just how difficult it can be in a low vol environment to make money on directional long premium options trades. You hear us say this again and again, you need to not only get direction correct, but also magnitude of move, And most importantly timing.
From a technical perspective, after making a new all time high last Thursday the stock is testing the prior breakout level, which could demonstrate weakening momentum if the stock can not hold recent gains:
And lastly, looking at the 3 year chart of 30 day at the money Implied Vol, prior to the recent spike, the investor on the trade highlighted above got long DIS vol very near the multi-year lows, but the uptick in near dated vols had little impact on the trade due to the longer dated nature of the options. The options premium still declined by 13% in just 40 days:
So the moral of the story is twofold. Valuations are stretched even for sectors outside the ones that Yellen mentioned and it will take some serious bubble buying to take some of these stock to significantly higher levels. And despite the apparent cheapness of options prices it still takes a lot going right to make money on long premium directional bets to the upside.
One trade we’d possibly be interested on an up day would be a short premium structure that looks for Disney to come back towards its 50 day moving average (mildly bearish). The Aug 87.5/82.5/77.5 is currently around 1.45 and we may be interested if it got closer to 1.25.