Disney Offers A Solid 88% Income Potential for Investors
Trade summary: A bear call spread in The Walt Disney Company (NYSE: DIS) using December $145 call options for about $5.45 and buy a December $150 call for about $3.10. This trade generates a credit of $2.35, which is the difference in the amount of premium for the call that is sold and the call.
In this trade, the maximum risk is about $265. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($235). This trade offers a potential return of about 88% of the amount risked.
Now, let’s look at the details.
Benzinga carried news of the company’s recent measures to reduce costs, “Media and entertainment giant Walt Disney Co (NYSE: DIS) confirmed in a regulatory filing update that approximately 32,000 employees will lose their jobs in the first half of 2021.
What Happened: Disney’s job cuts will mostly impact employees in its Parks, Experiences and Products business units, the company said. The COVID-19 pandemic has disrupted a business unit that relies on tens of thousands of customers visiting its theme parks on a daily basis.
Disney’s theme park in California, Disneyland, is not expected to reopen until at least 2021.
A “changing environment” resulted in management generating efficiencies in staffing, including limiting hiring to critical business roles, furloughs and reductions-in-force, according to the Mouse.
As of Oct. 3, approximately 37,000 employees who were not scheduled for employment termination were on furlough due to the negative effects of the pandemic, the company said.
Why It’s Important: Disney’s actions prompted it to suspend its semi-annual dividend in January, as management is using the funds to support its streaming video department instead.
Disney also cautioned investors that it may not declare future dividends moving forward.
What’s Next: Disney said it will take additional “mitigation actions in the future,” including raising additional financing, suspending capital spending, reducing film and TV content investments, enacting additional furloughs or further job cuts.
“Some of these measures may have an adverse impact on our businesses,” the company said.”
These steps seem to confirm the recent price action in the stock.
DIS failed to follow through on recent gains after rallying on news of a vaccine. Momentum turned down, as shown with the stochastics indicator at the bottom of the chart above.
The longer term chart below shows that the stock’s recent rally stopped at resistance that dates to the end of last year.
Resistance is a level where shareholders who suffered through a loss and now have an opportunity to sell near their breakeven price are likely to enter the market. Their selling pressure could limit the limit the upside of the stock.
DIS faces resistance as negative news about the company mounts. Overall, this is a potential bearish pattern and traders can seek to benefit from that with a spread trade.
A Specific Trade for DIS
For DIS, we could sell a December $145 call for about $5.45 and buy a December $150 call for about $3.10. This trade generates a credit of $2.35, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $235. The credit received when the trade is opened, $235 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $265. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($235).
This trade offers a potential return of about 88% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if DIS is below $145 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $265 for this trade in DIS.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Both the potential profit and loss for the bear call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.