Rationalizing Disney’s earnings

Unfortunately, I did not get the chance to discuss Disney Co. (DIS) on CNBC Wednesday, but I do have perspective to offer about trading ahead of the company’s earnings; this methodology can be applied at any time.   I am certainly not trying to play Monday morning quarterback on this one, but I suggested a short 28-put in December. As I said, I never got to share that trade.

Before I place any trade, whether it be options or stock, I asses the fundamental climate of the marketplace and the individual stock itself.  DIS, for example, has been cutting costs and changing the way it makes and markets moves in our current economic climate.   In many ways, buying DIS is placing a bet on economic recovery in an ancillary way, which I am bullish on the economy as a whole, save some exceptions.  DIS’s parks and resorts are a moderate chunk of its revenue and as attendance rises in the parks and folks spend more money at those parks and resorts, the company stands to benefit.   The economic ramifications also will manifest themselves in Disney’s studios , consumer products and lastly in its media division comprised of Disney-ABC, ESPN and its internet group. ABC ad rates are 20% higher than last year by the way. Theme parks didn’t fare so well; their profit fell 17%.

But there has been positive data (green shoots) beginning to emerge from several areas, including retail, media and even in tourism.

The markets are extremely efficient, certainly far from 100% efficiency, but generally efficient enough that information is digested and interpreted the best way it can, finding a valuation and multiple for the stock itself.  Most of the opinions that we form about stocks are shaped by the analysts and by the media.  Having a more bullish or more bearish opinion about a stock is not a bad thing, just make sure that your rationale for doing so is justified.  

With DIS, I looked at the past six months of performance in the stock versus its competitors. I also took a look at the company’s past activity in terms of percent gains over certain period of economic ebbs and flows and how it responds to certain data, if at all.

Once I have my basic fundamental opinion, it’s time to start taking a long hard look at some technical and statistical data.   At the end of the day, price is paramount.  One could have a strong stock that is growing with cash on hand trading at a lower multiple than its peers for one reason or another.  Sometimes, it may take a while before the most <em>appropriate value</em> is found for a company.

DIS is not typically a big mover over earnings reports,  as it moves around 5% on average.  The third quarter is also not one that I think would carry the same weight as a fourth-quarter report, which really takes into the holiday season, where DIS might be expected to perform a bit better.

 Disney shares are about double their March lows and they were up close to 4.5% to $30.40, surpassing the $30-mark for the first time since October 2008.

For this strategy, I have a moderate bullish view on DIS and wouldn’t have minded owning the shares down around $27 (28-strike minus premium).   Even after the volatility crush we are seeing this morning, the at-the-money calls are still yielding $1.10, or 3.6%, over a 35-day period.  If I had to get long the stock, I would immediately sell the at-the-money call and further reduce my $27 price point down below $26, which would put me at September levels.  Furthermore, DIS’s Monthly ATR is normally around $4. A move like that would have an extremely low probability (20%) by January, which will be about the time, where I could sell another call if I was not assigned on the first.

The point here is that with a little fundamental data and some contingency plans, you can generally find a way to trade anything – even Mickey Mouse!

Have a great weekend!!