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Go Long Disney And Hedge With A Covered Call

Jul. 29, 2013 11:02 AM ETDIS
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07/29/13 Covered Call Pick: Revisiting Walt Disney Company (DIS)

You can find our initial strategy on Walt Disney Company (DIS) here.

The Walt Disney Company currently has a market capitalization of $117.03 billion with 1.80 billion outstanding shares.

Walt Disney currently pays an annual dividend of $0.75 for a current yield of 1.2%.

With a beta of 1.02, DIS trades with more or less the same volatility as the current market.

Since we didn't get to a revisit on our previous investment of Disney last week, we decided it would be good as a spotlight for today, our last Covered Call of the month before heading into August. Our initial strategy on Disney saw us buy the stock at a $64.74 per share cost basis, while selling the July $70 out-of-the-money Call. While the stock did not get called away and the Option expired, there was still a small capital gain on the stock, as the strategy closed with the stock at $65.15, which has now settled last week to $64.98. Yet this also includes a pullback from the stock's recent 52-week high in May of $67.89. So why the stock pull back, and assuming that we still want to hold on to Disney (we do), where do we sell our next Call?

The pullback Disney saw from its recent highs are due to two major factors. The first being the overall market pullback that occurred in May, in which the majority of the market ran downward due to fears of Fed tightening caused profit taking. This has been discussed multiple times on this blog, and is irrelevant to anything specific about Disney as a company, so this is not a concern for us. The second major factor is the goose egg that Walt Disney Studios laid named "The Lone Ranger". The big-budget western starring Armie Hammer and Johnny Depp grossed only $48 million domestically and $24 million in foreign markets, while costing $215 million to produce. That's a huge dip into the red for the studio's books, and follows in the footsteps of other flops like 2012's "John Carter" and 2010's "Prince of Persia: The Sands of Time". The question is whether this recent disaster has threatened the integrity of the company's financials, changed our investment thesis, or has created a bearish trend of movie flops.

In a word: "No".

In both the last two instances of movie flops, the stock has pulled back on that news. Yet in both cases the stock has risen higher afterwards. This is mainly due to the fact that the street too heavily focuses on the fact these movies were misses, rather than the content the movies were actually about. Namely, none of these movies fall within the company's important film franchises. These would be the Disney-Pixar and Marvel franchises. These are where Disney will make money in the film business, and we believe the recent Lucasfilm acquisition will also yield huge dividends starting in 2015 when the first of the new Star Wars movies will come out of Disney. The movie line-up for Disney moving forward looks excitingly positive with a new "Thor" and "Captain America" movie coming out in the next year, with "Avengers 2", the follow-up the largest grossing movie of all time, slated for 2015. Any poor results for these movies, or any poor execution from the new Star Wars franchise, would cause us to pause and reassess the effectiveness of leadership at the company and whether the decisions made will end up affecting not only the bottom line, but the image of the studios and the stock. But now, we couldn't be happier with the way the company has managed their Marvel acquisition, and monetized properly to take full advantage of its popularity. Also remember, that Disney is more than just movies. Their parks and cruise ship division has been posting strong performance, and we expect to see more of that moving forward.

So where do we put the strike price for our next Call? Well moving forward we need to look at possible catalysts for movements in the stock price. The largest reasons for the stock to move in the short term that we can properly expect are earnings, the restart of ESPN NFL coverage, and the positive performance of any blockbuster movies. We do believe that earnings reports will be positive for the company, but the FQ3 one slightly tepid possibly due to the loss taken on "The Lone Ranger". ESPN remains one of the strongest cable content providers and a strong revenue generator for DIS. And the next large Disney blockbuster to be released is Marvel Studio's "Thor: The Dark World" this upcoming November. With all of these factors, we expect small movements in the stock up and down in the near term, until one of these catalysts kicks in to help propel the stock upwards. We'll be looking for the near term play to get paid for holding the stock while attempting to better gauge how the stock will move from the catalysts when they occur. A good level for a near-term strike price would be close to the stock's recent 52-week high. This provides a technical level for us to work around, and because our initial strategy was profitable, we have no requirements for our premium level to get to profitability. That is why we are recommending selling the October 2013 $67.50 out-of-the-money Call.

Scenario:
 

  • 100 shares of DIS @ $64.61 cost basis = $6,461 + Commission ($12.95) = $6,473.95
  • Write 1 DIS October 2013 $67.50 Call @ $135 - Commission ($8.70) = $126.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

(1.26)/64.74 X (365)/82

= 8.66% Static Return


If-Called Return:
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

(1.26 + 67.50 - 64.74)/64.74 X (365)/82

=27.64% If-Called Return


The TOTAL yields for the strategies include ALL the dividends collected, ALL the Call premiums collected, and are calculated over the duration of the ENTIRE strategy (from the inception point of buying the stock to the expiration of the most current Option). We will save you the math at this point and go into it more in depth upon the review of the current Option cycle.

Total Static Yield = 5.98%

Total If-Called Yield = 15.35%


Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

Posted by OaktreeAdvisors at 7/29/2013 9:53 AM
Categories: Weekly Picks

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Disclosure: I am long DIS.

Additional disclosure: As active managers we are long DIS and have calls written on a portion of our positions.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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