Name That Trade – $DIS Magic

by Dan May 4, 2015 12:42 pm • Commentary

Event: Disney (DIS) reports fiscal Q2 results tomorrow before the open, the options market is implying about a 4% event move*, vs the qtr average of about 2.75%. It is important to note that last qtr the stock rallied 7.6%, massively skewing the average versus the prior three quarters when the stock averaged about 1%, all moves lower.

* with the stock at $111, the May 8th weekly 111 straddle (the call premium plus the put premium) is offered at about $4.70, if you bought the move, buying the weekly straddle, you would need a move above $115.70, or below $106.30 to make money.  

Price Action / Technicals:  DIS is up nearly 18% on the year, and less than 1% from the all time highs in the stock.  A quick look at the 1 year chart shows the gap from the $95 lever to new all time highs back in early February on blowout earnings.  $95 should serve as massive support for the time being, as it also corresponds with the stock’s 200 day moving average (yellow). In the near term the recent consolidation near $105 and the gap level of $100 should serve as near term support.  On the upside, there is no overhead resistance:

[caption id="attachment_53313" align="aligncenter" width="600"]DIS 1yr chart from Bloomberg DIS 1yr chart from Bloomberg[/caption]

Valuation: DIS trades at 22.5x expected 2015 earnings growth of 14%, which is at a 10 year high, the stock is not particularly cheap trading at premium to both the market and most peers:

[caption id="attachment_53314" align="aligncenter" width="552"]DIS 10 year PE from Bloomberg DIS 10 year PE from Bloomberg[/caption]

Vol Snapshot;  short dated implied vol is approaching levels not see since the 10% sell off in the broad market in October, and well above levels where options prices usually get to prior to earnings:

[caption id="attachment_53315" align="aligncenter" width="600"]DIS 1yr chart of 30 day at the money IV from Bloomberg DIS 1yr chart of 30 day at the money IV from Bloomberg[/caption]

Options Open Interest and recent flow: Over the last month, call activity has averaged about 2.5 to 1 as 6 of the largest strikes of open interest are all calls.  On a couple of occasions over the last couple weeks we have highlighted out of the money call buying:

From April 28th: 

DIS – the stock continues to see bullish options flow in front of this weekend’s Avengers opening and next week’s earnings report (Friday saw a buyer of 10,000 May 111 calls for 1.70 to open, $1.7 million in premium). When the stock was 110.55, a trader sold to close 2,000 May 1st weekly 108 calls at 2.80 and bought 3,000 May 29th weekly 113 calls for 1.85 to open,earnings are on May 5th.

This has resulted in an interesting upside skew in the options, especially near term. Under normal conditions in a stock like DIS we’d see skew in downside puts (bid up for protection) and skew down in upside calls (overwrites). But what is becoming increasingly common in this market is that dollar cheap out of the money calls are being bought heavily by traders and investors looking for massive breakouts in stocks near highs:

[caption id="attachment_53321" align="aligncenter" width="458"]Screen Shot 2015-05-04 at 10.33.09 AM LiveVol Pro[/caption]

As you can see, the upside calls in weeklies (red), May regulars (yellow) and June (beige?) are all trading at higher implied volatility than the at the moneys. July (brown) and October (blue) reflect a more normal skew distribution.

Estimates from Bloomberg:
-2Q adj EPS est. $1.10 (range 83c-$1.18)
-2Q rev. est. $12.25b (range $11.89b-$12.82b)
2Q segment rev. ests. 

  • Media Networks $5.54b
  • Parks & Resorts $3.8b
  • Studio Entertainment $1.6b
  • Consumer Products $989.3m
  • Interactive Media $277.3m

2Q segment OI ests

  • Media Networks $2.11b
  • Parks & Resorts $531.7m
  • Studio Entertainment $300m
  • Consumer Products $335m
  • Interactive Media $20.3m

My View:  Positive sentiment seems to be at a fever pitch with this past weekend’s opening of the latest Avengers movie, and the building excitement for the impending Star Wars reboot in December.  But as you can see from the estimates above, the company gets their lion’s share of sales and earnings from Media Networks (like ESPN) and theme parks, not from movies that capture most headlines.  So the focus should be on advertising rates.

It is my sense given the stock’s performance since their last report, up 17%, the stock looks fully valued and the stock’s price likely reflects a beat of the quarter just reported and likely a modest guide higher. An inline quarter and a modest guide lower and the stock is down in line with the implied move, and possibly re-tests $105 in the days to come.

Call sales against long stock in the very near term look like a good way to add a little yield, or possibly a small buffer to the downside.