As Barchart featured author Mark Hake mentioned, Disney (DIS) appears to be relatively undervalued. Fundamentally, the Magic Kingdom generated positive free cash flow (FCF) last quarter and looks to sustain this run. Naturally, observing analysts recognized the potential opportunity in DIS stock, raising their price targets. On a technical level, this newfound sentiment has helped shares bounce off their lows.
Per Hake, one mechanism to extract positive returns from the optimistic dynamic is to “short out-of-the-money puts.” In other words, the idea here is to sell (or write) put options, which is a credit-based strategy. Unlike the more common debit approach, the concept of shorting puts is to receive premiums (income) and hope that the other side’s position blows up (in a bad way).
It’s a defensive play because the nature of short puts is to receive the benefit upfront. To use a sports analogy, you have the lead (income). Your job is to hold onto said lead and thus, win the game. However, if the security falls, you as the put seller (writer) lose.
In Hake’s example, he wrote about selling the $87 put with a Nov. 1, 2024 expiration date. At the time, this option carried a premium of 50 cents (or $50 when applying the options multiplier of 100 shares). As Hake stated, “an investor can make a short-put yield of 0.57% over the next month.”
Of course, if the trade goes south — that is, DIS stock slips below $86.50 (the $87 strike minus the 50-cent premium received) — the put writer would be obligated to buy 100 shares of Disney at the strike. Under a cash-secured put, that’s not necessarily a problem. You receive income if DIS doesn’t fall and buy shares at a low price if it does.
But what if you don’t have $8,700 to secure such a put? You can still participate in income-generating strategies — here’s how:
Barchart Premier Offers Equal Opportunities in DIS Stock
Let’s face reality. If you had plenty of dough and were a true supporter of Disney, you wouldn’t mind putting $8,700 at risk for DIS stock. Again, if red ink materialized for the security, you are already inclined to buy the dip. Stated differently, the $50 of income received is a nice little bonus that you can collect in a month’s time.
Nevertheless, not every investor is enthusiastic about DIS stock, especially following its choppy performance this year. So, a better approach — and one that involves more rewards and less risk (yes, you read that correctly) — would be to apply a multi-leg options strategy known as a bull put spread.
In terms of multi-leg trades, the bull put spread is one of the easiest. Here, you sell a put and simultaneously buy a put at a lower strike. The latter action chokes off the risk inherent in a sold options contract. Further, all sold options feature capped rewards. So, the bull put spread tends to be far more powerful for regular retail traders than selling straight puts.
Looking at the bull put spread options chain expiring on Nov. 1 (which can only be accessed by Barchart Premier members), the following idea could be attractive to many market participants:
- Sell the $91 put at a bid of $1.32 per contract.
- Buy the $85 put at an ask of 37 cents.
- The net income received comes out to 95 cents (this is the maximum reward).
- The max loss comes out to $5.05 per contract (or $505).
- Breakeven lands at $90.05.
- The risk-reward ratio is 5.32 to 1 (for every $1 of income received, $5.32 is at risk).
A couple of factors make this trade immediately attractive. First, the amount of cash at risk is fractions of shorting the $87 put ($8,700 versus only $505). Second, the reward is also much higher at $95, translating to a yield of 18.81%. Third, the idea is open to any trader who sees DIS stock stabilizing at current levels and not just well-off believers.
One Advantage that the Covered Put Delivers
Although the bull put spread offers significant advantages, it does feature one disadvantage relative to the covered put that my colleague mentioned. Should the position go up a foul-odor creek without a paddle, the put seller would be assigned (forced to buy the underlying security at the strike price).
Again, if you believe in the stock, that may not matter much. With a bull put spread, there are limited mitigatory avenues to take if the security moves unfavorably, such as closing the position early or rolling the spread. Aside from certain nuances, when you lose in a spread, you just flat out lose.
Still, all things considered, I’d rather go with the bull put spread. You’re getting much higher returns and you’re nominally putting much less money at risk. Plus, if DIS stock craters to $50 for example, the straight put seller must buy back the security at the $78 strike price. For presumably most investors, that would be a difficult pill to swallow.
On the bull put side? Your risk is predefined (at $505, in this case) and can never be more than the maximum stated. With respect to covered call writers, an options spread seems to make much more sense here.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
