On Friday I detailed a diagonal call calendar to play Disney’s (DIS) earnings that were reported last night, and discussed the strategy on Friday’s Options Action on CNBC:
Here was the trade idea:
DIS ($101) BUY MAY 105 – SEPT 100 CALL DIAGONAL FOR $5
-Sell 1 May 105 call at 80 cents
-Buy 1 Sept 100 call for 5.80
Break-Even on May expiration:
The maximum risk to this trade is the $5 at risk on a sharp move to the downside.
Best case scenario the stock moves towards 105, in this situation the Sept 105 call will pick up nearly $2.50 in deltas, while the May 105 call will pick up about $1 in deltas but will see extrinsic value (currently 80 cents) come out as it is about 8 trading days from expiration with the event beyond it.
Rationale: while potential profits are capped between now and May expiration (two weeks) this trade idea targets a near-term move back towards 105, and helps finance owning an in the money call at which point you could roll the profits up and out.
Disney reported last night and the stock is trading down about 2% to $100, or $1 above Friday’s close. Let’s walk through how to manage this trade. The May 105 calls that could have been sold at 80 cents on Friday afternoon are now offered at 20 cents for a 60 cent gain. The Sept 100 calls that could have been purchased for $5.80 on Friday can be sold at $5 for an 80 cent loss. At this point, if you were to take off the position the trade would have lost 20 cents.
So what to do? There is a very low probability that the stock will be up 5% over the next 7 trading days, so I think there is little reason to panic to cover the May 105 call for 20 cents. But I might consider turning this trade into a calendar by rolling the May 105 call to June. IN this case, I would buy to cover 1 May 105 call for 20 cents and sell to open 1 June 105 call at $1. This roll results in a 80 cent credit, further reducing the premium at risk and having a very similar profit profile between now and June expiration as we did prior to earnings.
Action: DIS ($100) Buy to close 1 May 105 call for 20 cents
Action: DIS ($100) Sell to open 1 June 105 call $1
New Position: DIS($100) Long June 105 / Sept 100 diagonal call calendar for $4.20
The main idea here from the beginning was that near-term catalyst might be scarce and this trade idea helps to chip away at the longer dated calls that might catch a breakout later in the year.