The holiday season in my household is a time when family and friends gather to spend quality time together, celebrate religion and to look back on the year. What doesn’t make it into the timeless videos and photos is my wife swearing under her breath about breaking her favorite Christmas ornament (a yearly tradition), my kids inevitably getting a stomach bug as family is arriving from out of town, or the gross overspending on toys which will soon be discarded when the next hot toy sweeps the nation.
Unless you have been living under a rock for the past six months, you know that Star Wars: The Force Awakens recently hit theaters. The advertising has been non-stop for months, and has gone from traditional mainstream media advertising to extremely obscure cross-promotional opportunities such as Star Wars coffee creamer and Cheez Its. As one might imagine, much of this advertising has worked, and Star Wars toys are the “must have” for this Christmas season.
In fact, on the top of my kids’ wish list for Santa this year was Star Wars … Star Wars … and more Star Wars. What is so interesting about this is that my kids are seven and four years old, and neither had ever seen any of the Star Wars movies, and couldn’t name one character. Yet, they HAD to have Star Wars toys!! The non-stop advertising and branding had worked.
This successful advertising has made Disney (DIS), which owns the rights to Star Wars, one of the most talked about stocks in the market in the last several months as the newest movie release has shattered box office records. Traders have been betting on Star Wars success all year, and DIS stock is up 12.5% year-to-date.
However, there have been growing concerns about DIS stock as ESPN, which is an integral part of the company’s television business, has been losing some momentum as more and more people have been cutting the cord on cable. Because of these growing concerns about the television business, I might look to buy a Call option on DIS rather than buy the stock. Calls give investors similar upside exposure to owning the stock, but at a fraction of the cost.
For example, if I wanted to put on a bullish position, expecting continued blockbuster movie sales and merchandising success to propel DIS stock higher, I would look to put on a bullish position for DIS earnings, which are expected to be released in February. I might buy the DIS February 105 Calls for $5.00. If I were to purchase one of these calls for $5.00, this is actually a capital outlay of $500. However, the purchase of one call would give me very similar upside exposure to owning 100 shares of the stock, at a fraction of the cost. In this case, instead of buying 100 shares for 106, or a capital outlay of $10,600, I can get similar upside exposure at a total cost of $500.
Here is the profit and loss graph of buying one DIS February 105 Call:
As this graph illustrates, the most I can possibly lose on this position is the premium paid on this call, or $500. However, my upside is unlimited, much like the purchase of the stock.
While Disney has positive momentum in its brand, on the other end of the spectrum is Chipotle Mexican Grill (CMG). Chipotle is dealing with a marketing/brand crisis as a multistate E. Coli outbreak tied to the company’s food is raising major questions about the company. In just the last month CMG stock has lost close to 15%.
While I’m not in a rush to go back to eat at Chipotle, I’m guessing in time, I, like most consumers, will forget about this current food safety issue, and return to dining at this popular mexican restaurant. With that in mind, and the belief that this issue will soon pass, if I were to want to get long CMG for an eventual stock turnaround, I might buy CMG Calls instead of buying the stock.
For example, while I don’t anticipate a stock turnaround in the days/weeks to come, and knowing that I will not be able to pick the bottom in a stock in crisis, I might instead look to buy calls that expire in June. Instead of buying 100 shares of CMG at 495, for a capital outlay of $49,500, I might look to buy one of the CMG June 530 Calls for $38.00, for a capital outlay of $3,800. While $3,800 is a significant amount of money to buy calls, especially in comparison to the price of DIS options, CMG shares have in just the last two months traded as high as 757. This upside potential is one of the reasons that these calls are so expensive.
Here is the profit and loss graph of buying one CMG June 530 Call:
As this graph illustrates, the most I can possibly lose on this position is the premium paid for the call, or $3,800. However, my upside is unlimited.
Exactly, when fads such as Disney’s Star Wars, or crises like Chipotle’s, will end is impossible to guess. However, by buying calls, instead of buying the company’s stock, traders and investors can get similar upside exposure to these events, at a fraction of the cost.
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With a little education, options trading can be simple, low-risk, fun and most importantly, profitable.
Your guide to successful options trading,
Chief Analyst, Cabot Options Trader
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