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This article serves as the second in a series focusing on the use of LEAPS (Long-term Equity AnticiPation Securities) options to establish bullish and bearish positions in different sectors of the stock market. If you are unfamiliar with LEAPS options, read and bookmark this excellent description from the Chicago Board Options Exchange (NASDAQ:CBOE).

You can view the first article in this series, which outlined a LEAPS option approach to tech and Internet here.

Investors can benefit from using LEAPS in several ways. As with near-term options contracts, you can participate in the direction a stock takes without having to put up the amount of capital necessary to buy shares of the stock outright. Each options contract you purchase gives you the right, but not the obligation, to

buy or sell 100 shares of the underlying security at the option's strike price on or before the contract's expiration date. LEAPS options give investors the opportunity to make a longer-term play on their prediction of a company's fortunes, while limiting downside risk.

Generally, the plays I suggest will have the following in common:

  • They will be relatively simple to execute; in particular they will not require that you access large amounts of margin, if any.
  • Unless the underlying stock blows past your breakeven point, I do not intend for you to hold these positions to expiration.
  • They should be received as starting points for your own due diligence, not recommendations to immediately enter any position on blind faith.
Disney (NYSE:DIS). Disney is about as diversified as it gets. And, as of its last quarterly report, all five of its business segments appear to be on firm footing. Disney's total revenues for the quarter ended January 1, 2011 totaled more than $10.7 billion. The company's media networks segment, which includes television and radio stations and networks ranging from ABC to ESPN, saw revenues grow to more than $4.6 billion from $4.175 billion in the same quarter the year previous. Parks and resorts, consumer products, and interactive media all grew, while the studio entertainment segment was basically flat, due largely to a change in how Disney counts revenue between studio entertainment and media networks. The tweak caused the latter's higher revenues and the former's flat performance.

In any case, millions of reasons exist to like DIS at its present value. Its various business segments hedge against one another. ESPN continues to experience strong advertising growth, well into the double digits. Despite poor weather conditions in Europe, Southern California, and the Northeast, the company's theme park business did not take a massive hit. Disney's balance sheet is sound and its $0.40 dividend makes it a viable buy-write candidate. When considering dividends, however, as an individual investor, you have to do some math. Five hundred shares of DIS would only yield about $200 a year in income. With this in mind, I would prefer to initiate a stake in call options, where I can use less capital and still participate strongly in potential price per share appreciation.

I don't think the bottom will fall out of Disney stock anytime soon. At the same time, I don't see it hitting $100 a year or two from now. I think a simple call option strategy make sense.

DIS is the type of stock many investors dollar-cost-average into or buy a chunk of and then freeze their brokerage account password in a block of ice. I take no exception to these approaches. You can, however, make a similar longish-term play by purchasing DIS in- or at-the-money call options. Looking out to January 2013, the $40 and $45 calls both look attractive, priced at $7.65 and $5.15, respectively, as of Friday's close. The breakevens on each play -- $47.65 and $50.15 -- both seem perfectly attainable, given DIS's range of $40.87 to $43.24 last week.

Electronic Arts (ERTS). I owned shares of EA competitor Activision Blizzard (NASDAQ:ATVI) until I just couldn't take it any longer. ATVI's refusal to evolve and become, at least partially, a new media company provides shareholders with absolutely no confidence in the firm's future. As Apple (NASDAQ:AAPL) proves repeatedly, you can't rest on a franchise. That's exactly what ATVI appears to be doing

with seemingly vague plans after Call of Duty's smashing success. Electronic Arts, in the meantime, generated 20 percent of its revenue last quarter from games designed for devices such as the iPad, iPhone, and Amazon.com's (NASDAQ:AMZN) Kindle. And the stock has been performing better than it has in months, in a somewhat topsy-turvy market.

ERTS's forward guidance sparks even greater optimism. Most people expect sales of

ERTS franchise Madden NFL to suffer if the NFL and the NFLPA does not resolve its labor dispute prior to the start of the season. The company, however, still guided up, anticipating double-digit EPS growth, year-over-year. During the company's last earnings call, CEO John Riccitiello explained that the guidance operates under the assumption that there will be no NFL season. He expects "further upside" if NFL owners and players deliver better news.

Once ERTS breaks $20.00 again, it should test its 52-week high of $20.24. If it breaks and holds above $20.00, I expect more upside. While it might make sense to wait for another strong quarter and any dips on negative NFL-related news, I don't think you lose in the end by scaling into a position in ERTS January 2013 calls. Because I think ERTS morphs into a $30-plus stock by the end of 2012, I would be comfortable with just about any available call, even an out-of-the-money lotto ticket. For example, you could secure the ERTS Jan 2013 $30 calls for $1.02 on the ask at Friday's close. That said, it makes the most sense to enter the ERTS January 2013 $20 calls, which closed at $3.00 this past Friday. Even if you had to pay Friday's closing ask price of $3.70, you get into the position with an incredibly realistic breakeven point of $23.70, which represents an

increase of just over 20-percent from ERTS's Friday close of $19.70.

Because I would not feel comfortable holding more than DIS and ERTS in the media / entertainment space, I will stop there.

Executing the Media/Entertainment LEAPS Portfolio with $10,000
Contract Quantity Cost Initial Target Initial Profit
DIS Jan 2013 $40 Calls 5 $3,825 $10.00 $1,175
DIS Jan 2013 $45 Calls 3 $1,545 $8.15 $900
ETRS Jan 2013 $20 Calls 10 $3,700* $10.00 $6,300
ETRS Jan 2013 $30 Calls 7 $714* $5.00 $2,786

*Attempt to secure a better price for the ETRS calls

For each LEAPS option, I would plan on selling at least half of my position, if not most of it, at the initial targets listed. The $11,161 total profit represents an optimistic 119 percent gain on the total investment of $9,784, which left $216 set aside for commissions and a six-pack of beer. Of course, you'll have to tweak these numbers based on your own circumstances.

As most speculations on the stock market tend not to turn out this well, you should set either firm or mental stop losses on each position. Just as I suggest you do your own due diligence as opposed to taking my advice as anything more than an idea, you'll need to determine how much you feel comfortable putting at risk. If you use stops, the cost of the position does not represent your risk; rather, the difference between your cost and the proceeds you would receive if your stop was triggered represents the amount you are risking. It's a fine line between preventing losses and failing to recognize head fakes a stock gives throughout the duration of a relatively long position.

To view similar ideas, but in the tech and Internet space, see my initial article in this series.

Disclosure: I am long AAPL.

Source: Developing a Media, Entertainment Portfolio Using LEAPS Options