Disney (DIS) Stock Looks Undervalued; One Way to Play This Is to Short Out-of-the-Money (OTM) Near-Term Puts and Going Long In-the-Money (ITM) Calls in Long-Dated Expiry Periods

DIS stock closed at $111.16 on Friday, Jan. 3. It's been flat since Nov. 14 when it was at $109.12, after Disney released its fiscal Q4 and full-year earnings on Nov. 13.

The Walt Disney Company (DIS) stock has been trading flat, but it still looks undervalued using several measures, including dividend yield and free cash flow. One way to play this is to short out-of-the-money (OTM) near-term puts and going long in-the-money (ITM) calls in long-dated expiry periods.

DIS stock closed at $111.16 on Friday, Jan. 3. It's been flat since Nov. 14 when it was at $109.12, after Disney released its fiscal Q4 and full-year earnings on Nov. 13.

That makes it attractive to investors who sell short OTM puts and buy long-dated ITM calls. This article will delve into this more carefully.

DIS Stock Looks Undervalued

Historical Dividend Yield. I wrote that DIS stock looked undervalued in a Dec. 6, 2024, Barchart article, “Disney's 33% Dividend Hike Implies DIS Stock Could Be 35% Undervalued.”

I showed that based on its historical dividend yield DIS is worth $138.89 per share, based on its historical dividend yield of 0.72%:

$1.00 dividend per share / 0.0072 = $138.89 target price

That is 25% higher than Friday's closing price of $111.89.

Moreover, given its highest trading price, the stock could be worth as much as $152 per share.

Free Cash Flow. In addition, using a free cash flow (FCF) analysis, Disney could be worth as much as $164 per share. Here's why.

Analysts forecast that sales this fiscal year (ending Sept. 2025) will reach $94.85 billion. And the following year they estimated $99.97 billion. So, for the next 12 months, the run rate revenue is about $97.4 billion.

Since last quarter Disney made a 17.85% FCF margin, let's assume it make at least 17% going forward:

$97.4 billion NTM sales x 0.17 = $16.6 billion in free cash flow (FCF)

Using a 6.0% FCF yield metric, this means that Disney will end up with a $276.7 billion market value:

$16.6b / 0.06 = $276.7 billion market cap

That is 37.5% higher than its present market cap:

$276.7b projected mkt cap /$201.3 billion mkt cap today = 1.375-1 = +37.5%

In other words, using an FCF metric, DIS stock is worth $153.85 per share:

$111.89 x 1.375 = $153.85 per share

What's the best way to play this?

Shorting OTM Puts

One way to play this is to repeatedly sell short out-of-the-money cash-secured put options in near-term expiry periods. That means selling puts in strike prices below the trading price.

For example, look at the Jan. 31, 2025, expiry period, which is less than a month away (27 days to expiry or DTE).

It shows that the $108.00 strike price, about 2.8% below today's price, has a put premium of $1.07 on the bid side. That means the short seller can make a 1.0% yield in less than one month: (i.e., $1.07/$108.00 = 0.99%)

This means that an investor who secures $10,800 in cash or buying power with their brokerage firm can do this trade. They enter an order to “Sell to Open” 1 put contract at $108.00. That cash acts as collateral in case DIS stock falls to $108 and the account is assigned to buy 100 shares at $108.00.

The account will then immediately receive $107.00. Hence the yield is almost 1.0% (i.e., $107/$10,800 = 0.99%). No matter what happens, the account keeps that income.