Name That Trade – $DIS: Let it go

by CC August 31, 2015 12:56 pm • Commentary

Earlier in his MorningWord, Dan said that some of the best trades on the board after last week’s late week bounce in the fade the bounce of some of the market’s fallen angels, like Disney (DIS):

The five year chart shows the very steady uptrend that had been in place since late 2011, the massive breakout in early 2015, and the stock’s subsequent parabolic move that took the chart too far above trend. The sharpness of the recent correction suggests that rallies should be sold until proven otherwise. A break below the uptrend and last week’s lows near $90 could put the 52 week low just below $80 back in play on further broad market weakness:

DIS 5 year chart from Bloomberg
DIS 5 year chart from Bloomberg

The main point here is that DIS is no longer in the hands of the true believers. The theme park performance, a hit like the Avengers, excitement about the upcoming Star Wars movie or ESPN’s premium demographics seemed to justify a massive premium to the market and peers. But that may no longer be the case. Because now it’s a market story and there are very few positive headlines that will change that until the global-macro concern fades.

We identified $90 in DIS as an area to target for a long entry. We don’t like the stock here after the bounce from that area. If those global macro market trends do continue that area could be in play a second time.

Short dated options prices, despite coming in fairly hard late in the week, remain fairly elevated, with 30 day at the money implied volatility just below 30%, down from 40%, but still well above the 1 year average in the teens:

[caption id="attachment_56507" align="aligncenter" width="600"]DIS 1 year chart of 30 day at the money implied volatility from Bloomberg DIS 1 year chart of 30 day at the money implied volatility from Bloomberg[/caption]

Those that agree on the thesis and like the idea of defining their risk for a pullback towards 90, but are hesitant to commit premium to options on a directional basis in the current vol environment, might consider the following trade structure, selling a call spread to buy a put spread.  The idea here is to mitigate the potential for the stock to settle, or even grind in your desired direction while watching options premiums get destroyed.

The next identifiable catalyst will be fiscal Q4 earnings in early November, which seems like a logical period to target. We are not trading this stock here but the hypothetical trade we’ll detail is indicative of our feelings about the stock here.

Hypothetical Trade: With the stock ideally at $105 (but using today’s price of $102.25) you could sell the November 110/115 call spread at $1.20 (selling the Nov 110 call at $2.35 and buying 1 Nov 115 call for $1.15) and use the proceeds to buy the Nov 95 / 87.50 put spread for $1.40 (buying 1 Nov 95 put for $2.95 and selling 1 Nov 87.50 put at $1.55).

Cost: The net debit for this trade is 20 cents (subtract the credit of the call spread sale of $1.20, from the debit of the put spread purchase of $1.40)

Break-Evens on Nov Expiration:

Losses: The max risk of this trade is the $5 width of the short call spread sale (plus the 20 cents in premium).  Lose up to $5.20 between 110 and $115, max loss of $5.20 above $115.

Neutral: If the stock is between 110 and 95 lose the 20 cents in premium paid.

Gains: make up to $7.30 (width of the put spread less the premium paid) if the stock is between 95 and 87.50, with max gain below 87.50.

Rationale: The idea here is to be as premium neutral as possible, while also defining ones risk. Risking a loss of $5.20 to make $7.30 may not be a sort of home run risk/reward, but it is a matter of conviction. If the last two weeks have shown us anything it’s that $100 stocks can and will move 5% at a clip. If DIS did make a quick move lower our thesis would again change, but after this rally back above 100 we think a re-test of the lows first is very possible.