209% Bear Trade With Disney Falling Apart

Google+ Pinterest LinkedIn Tumblr

Wall Street lives and breathes earnings season. While trade wars, geopolitical tensions and economic unrest affect long-term price movements, nothing quite unsettles a stock’s short-term price like a missed earnings report.

The Walt Disney Company (DIS) announced its most recent quarterly figures last week. The company showed signs of serious acquisition fatigue. Its recent moves to buy Fox and take on Netflix with its Disney+ streaming platform are starting to cause significant margin depletion.

While you’ll be hard pressed to find many investors or speculators taking a long-term bearish view of the company’s strategy to become a content behemoth, they are still selling off in the short term.

After its earnings miss – which was a bad one, $1.35 per share vs. expected $1.75 – shares have fallen from their peak of $147 at the end of last month to $133 as I write.

While this move represents a terrible 9.5% decline, it barely touches the gains many investors still hold from Disney’s tremendous first half of the year.

Screen Shot 2019-08-15 at 2.29.08 PM.png

As you can see, investors have been quite bullish on the company’s future. Many remain so, despite this quarter’s poor numbers. But that doesn’t mean it will get better anytime soon.

One of the core sticking points between investors is over the company’s price tag for a subscription to its soon-to-launch Disney+ service. This streaming platform will include content from its own library, plus ESPN and Hulu. It will cost customers $12.99 per month for this service… exactly what Netflix is charging.

The idea is to undercut its competitor right out of the gate to try and tease its customers over to Disney’s service. Investors seem mixed on this plan. While it might be the right move, it won’t be without pain.

At that price tag, Disney won’t be able to keep very large margins on its new product. The cost of owning all that new content is still filtering through its debt-laden balance sheet. And by selling it so cheap, just to compete with Netflix, means it won’t be able to recoup much of that cost.

Long term, this isn’t a real concern. It is clear that its copyrights to mega franchises like Star Wars and Marvel will continue to pay the bills for years to come. And this new Disney+ service, once launched and gains a bit of a track record and subscribers, will eventually take in more than it costs for the company. But that day is still some time away.

So, for Wall Street, especially the volatile one we have today, there’s room in the short term for further price declines. In fact, with Disney’s other business – its theme parks – showing serious weakness right now, profit taking should only increase in the short term.

This presents a rare opportunity to take profits on the downside of a stock that will eventually continue to climb.

Shorting such a play is obviously not the best move here. But through an options strategy we favor here, there is an alternative way to play it.

A Strategy For Short Term Bears

A bear put spread is a type of net debit options trade that involves buying a put option with a strike price near the current trading price of a stock you believe is set to fall in the short term… and then selling a second put with a lower strike.

What this does is give you a chance to profit as prices slide lower, but at reduced risk. The premium collected from the short put helps offset the cost of the long one. This reduces the total cost of the trade and the total amount at risk.

It does, however, also cap the maximum potential profit if shares do collapse more thoroughly than expected. For such a solid long-term company like Disney, a complete wipeout in value is next to impossible. Instead, this strategy lets one take advantage of the slight decline without taking on too much risk.

You can see how this strategy works here:


Source: The Options Industry Council

Clearly, if Disney bounces back to its pre-earnings price, this trade will end with losses. But with so many more dominos to fall in the short term – shrinking margins, underperforming box office sales and theme park attendance – a short term decline is far likelier.

Let’s look at a specific example to see how this kind of trade might play out…

A Specific Trade on DIS

Right now, a trader could buy a September 20 $135 put for $4.31 per share and sell a September 20 $125 put for $1.07 per share for a net debit of $3.24 per share. Since each represent 100 shares of DIS, that’s a total cost of $324.

Now, if shares rally back from here, that’s the total amount at risk. But if shares do continue to decline in the short term, as should happen, the payoff is far richer.

To find that, take the difference in strike prices ($135 – $125 = $10), and subtract the cost ($10 – $3.24 = $6.76). In other words, if shares do slip down to $125, that’s a maximum profit potential of $676.

That represents a return of 209% on the amount at risk. Still, to collect this full amount, shares would have to fall about 6.4%. Though, that’s not a big challenge.

Based on its recent price movement, DIS shares could fall back down to its 200-day moving average of about $122 pretty easily.

Screen Shot 2019-08-15 at 2.29.20 PM.png

This trade opportunity is the perfect way to take advantage of Wall Street’s short-term purview, without risking betting against Disney’s clear long-term advantages. And if it goes as expected, a solid 209% return on risk is hard to beat.

Write A Comment