Disney’s Triple Threat Could Provide an 81% Gain
Trade summary: A bull call spread in The Walt Disney Company (NYSE: DIS) using the June $123 call option which can be bought for about $3.95 and the June $130 call could be sold for about $1.46. This trade would cost $2.49 to open, or $249 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $2.49. The maximum gain is $451 per contract. That is a potential gain of about 81% based on the amount risked in the trade.
Now, let’s look at the details.
DIS is a multi-pronged entertainment giant.
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The company might be best known for its theme parks. They closed for the pandemic but are beginning to reopen around the world.
“Shanghai Disneyland sold out of tickets for its May 11 reopening after a four-month shutdown, a sign that consumers in China are prepared to spend as the nation recovers from the coronavirus pandemic.
The theme park is implementing safety measures, including limiting visitors to one-third of the normal capacity of 80,000,” according to news reports.
This is a good indicator that some business could return to parks as they reopen around the world. This is important for the company because theme parks contributed about 46% of operating income in the company’s most recent fiscal year, more than double earnings from its studio entertainment business,
That studio business could recover as the company adapts to the new normal. According to Variety, “a whopping 70% say they are more likely to watch from their couch, while just 13% say they are more likely to watch at a local cinema (with 17% not sure).”
DIS could profit from this model, especially studios retain about 80% of the digital rental or purchase fee, compared with about 50% of box-office sales.
Finally, the sports could boost Disney. Sports are always important to DIS with its ownership of ESPN. They could be even more important as ESPN notes,
The NBA has entered into exploratory conversations with The Walt Disney Company about resuming its season at Disney’s ESPN Wide World of Sports Complex in Orlando, Florida, in late July, NBA spokesperson Mike Bass said [recently].
“The NBA, in conjunction with the National Basketball Players Association, is engaged in exploratory conversations with The Walt Disney Company about restarting the 2019-20 NBA season in late July at Disney’s ESPN Wide World of Sports Complex in Florida as a single site for an NBA campus for games, practices and housing,” Bass said.
“Our priority continues to be the health and safety of all involved, and we are working with public health experts and government officials on a comprehensive set of guidelines to ensure that appropriate medical protocols and protections are in place.”
This news is now supporting the stock well above its March bottom.
The recent break-out can be seen in the long term chart and could be a signal that the price will move quickly towards its 52-week highs.
A Specific Trade for DIS
For DIS, the June 19 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A June 19 $123 call option can be bought for about $3.95 and the June 19 $130 call could be sold for about $1.46. This trade would cost $2.49 to open, or $249 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $249.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in DIS, the maximum gain is $4.51 ($130- $123= $7; $7-2.49 = $4.51). This represents $451 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $249 to open this trade.
That is a potential gain of about 81% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying DIS could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull 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.