Walt Disney stock has been one of the weaker large-caps in the market recently. On the latest rally attempt, it couldn't even reach the declining 50-day moving average.
I'm willing to look at an option trade that will profit if Disney stock comes back down toward 85 in the next month.
The trade is a directional butterfly, centered at 85 with the view that Disney might retrace to that level.
A butterfly is a limited risk and limited profit trade. But on a typical butterfly trade, the profit potential is higher than the potential loss. In this case, it's a lot higher.
Placing the trade out-of-the-money means it can be done for a low cost with a high profit potential.
Butterfly spreads involve three different option strike prices, all with the same expiration date. They can be created using either calls or puts.
Setting Up Butterfly Spread
Because we are placing the butterfly below the market, we will use puts in this case to reduce the risk of early assignment.
Here's the trade I'm looking at:
- Buy 1 July 21, 75-strike put at 0.10
- Sell 2 July 21, 85-strike puts at 0.55
- Buy 1 July 21, 95-strike put at 3.90
The total cost of this trade is $290, and that is the maximum loss potential on the trade.
The maximum gain is $710. That's calculated by taking the difference in strike prices less the premium paid ($1,000 less $390).
If Disney doesn't get down to 85, I lose a little bit. But I have the potential for a large payoff if it does hit 85 in mid-July.
Trade On Disney Stock Could Lose $290
For a trade like this, it either works or it doesn't, and I'm prepared to lose the whole $290 if it doesn't work out.
According to the IBD Stock Checkup, Disney stock is ranked No. 12 in its industry group and has a Composite Rating of 24, an EPS Rating of 27 and a Relative Strength Rating of 29.
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Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
