Bernstein Research joined the bevy of downgrades to the media space, dropping one on Walt Disney Company (NYSE:DIS) Thursday from 'outperform' to 'market perform'. That makes three downgrades this month for Disney. Is it time to sell the stock? Maybe. But that depends on your timeframe. If you're a momentum trader, you may find a better opportunity lower or in a couple of weeks.
But if you're at the other end of the spectrum, you've got some work to do. For the long-term holder, a pronounced selloff like this is an opportunity to implement a stock-repair strategy. The downgrades have brought Disney down to about $101.
And if you have owned the stock since the bottom in 2011 at 30, it's unlikely that you'll be parting with it at this price. So what can you do? The stock-repair strategy is one where you add an options combination to the stock to ramp up your return as the stock recovers.
The specifics are to buy a Call Spread and sell a Covered Call so that the Call Spread appreciates with the stock up to the Covered Call strike. For Disney, you'll want to give it enough time to recover; so for my clients, I bought an October 105/110 Call Spread for $1.40 on Thursday. If the stock recovers to 110 by October Expiry, that would be a $9 return from the stock and a $3.60 gain in the Call Spread, or a total of 12.6% return in the position.
But that still leaves the Covered Call to sell. Here you have two choices. You can go with a short Expiry and sell the August 28 Expiry 102 Calls for $1.43, or you can go with a longer Expiry and sell the January 115 Calls for $1.85.
The short trade allows you to sell Covered Calls again, but also allows you to adjust if the price moves up quickly next week. The longer trade gives more time and more upside without the need to manage frequently. The key is that the Covered Call pays for the Call Spread. That way there's no cost to leverage the upside.
I sold the January 115 Call for $1.85, which brought the net cash outlay for the options combination to a 45-cent credit. So if the stock were to move to 110 by October Expiry, the gain would be 15.45%, which would still leave you with upside room to 115 until January.