Dow constituent and entertainment and leisure giant Walt Disney (DIS) reports after the close Tuesday night. With consumer spending, particularly the discretionary kind, so critical to the US economy and one that’s looking weak in the knees of late as evidenced by very recent reports on the labor market and GDP; what the company has to say regarding its top and bottom-lines and outlook, are about as important a corporate confessional this week as any.  

The Number

For its FY12Q2, Analysts expect Disney to produce profits of $0.55 per share compared to the prior year’s figure of $0.49 and percent increase of about 12.25%. At the same time, forecasted revenues of $9.55B represents growth of 5.3% from the year-ago period’s $9.07B.

Figure 1: Disney (DIS) Past Top & Bottom Line Data

Trader reaction to the past four reports has been both varied and muddled when comparing headline results to Street estimates shown above in Figure 1. Working backwards from last quarter’s mixed bottom-line beat and below views, near flat revenue growth, on a close-to-close basis, reaction in DIS shares is as follows: 0.71%, 5.95%, a very volatile -9.11% despite top and bottom-line beat and -5.44%.

The Chart

Figure 2: Disney (DIS) Daily Chart

For bears looking to the technical tea leaves for clues, the daily chart is shaping up (mostly) as a flag pattern coupled with a W5 completion. The bearish formation has developed courtesy of a gap breakdown of prior uptrend support on the heels of a double top formed when 2011’s highs were challenged and failed. This pattern also sports compliant weakness in the Oscillator 5, 35 during 2012. “BOO-yah!”

And for the bulls still not seeing the ride higher as yet over, the weekly chart (not shown) maintains a W5 mid-TAPP objective of $50 by the end of July / early August. Shares are back above the well-watched 50SMA and we’d be remiss if we failed to note one trader’s daily bearish flag is potentially a bull’s “high handle” consolidation which has formed after the 2011 highs were narrowly broken to the upside.   

Option Activity

In Monday’s session, option activity in Disney saw a rather strong favor towards its calls by roughly a three-to-one margin. Somewhat interestingly, the action responsible for those sometimes accurate heat-seeking actions laid mostly in the October calls. Heavy opening activity in both the 45 and 46 call on volume of roughly 7,000 and 9,000 apiece topped the board.

With both contracts slightly out-of-the-money and premiums under very modest pressure on the session, the action may have been driven by sellers. But with implieds also inside their three month trading range and only having a partial look at what appears to be a bunch of unrelated prints; we wouldn’t bet the ranch, let alone Mickey’s Magic Kingdom on whether buy or ratio writes, verticals or long calls were yesterday’s popular ticket with traders.  

In Tuesday’s early going and shares of DIS down about 1.20%; a long call buyer in Monday’s most active October 45 or 46 calls would now require a bit more than 13% out of shares by expiration in order to see a double in the price of those contracts. Prior to that day and one still some 163 calendar days out, implieds can be expected to be under modest pressure of 10% to perhaps 15% or into the low 20s and counter some of the delta value, if shares were to rally following the report.

Expected Move

Option activity Tuesday has been only moderate, but with shares near the 43 strike at 43.25, the May straddle with nine days left until expiration is priced for $2.30 per spread and as a result maintains break-evens of 5% to 5.50%. That’s mostly on par with two of the immediate post-earnings reactions detailed earlier and well below the most volatile -9.11% fallout from its less-than-well-received Q3 top and bottom-line beat.

Figure 2: Disney (DIS) 5x Short May 43 Straddle

For more theoretical types interested in bell curve analysis and the concept of continuous hedging, current implieds of 38.5% in the May ATMs tell us traders collectively expect a 1SD or 68% chance shares of DIS to remain within roughly 6% of current levels through expiration next Friday.

If DIS shares were to take the road less traveled and more or less sit, those traders might expect a beneficial volatility crush in the likes of a short straddle. An estimated 40% reduction in implieds from 38.5% to 23% and in the low range of Disney’s near-term pricing over the past three months would look like Figure 2 above, which illustrates the strategy using the short ATM May 43 straddle on five contracts. Call us “goofy”, but that’s a ride we’d be willing to forgo in today’s theme park of more bearish and fractured action.

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.