Enis’s Macro Wrap – Revisiting the $NFLX Range Trade

by Enis December 4, 2012 7:29 am • Commentary

With a relatively quiet overnight session (SPX futures have traded in a 6 point range and now indicate an unchanged open), I wanted to talk about NFLX this morning.  The stock was quietly down 7% yesterday.  I say quietly because the stock sold off from $82 to $76 in a gradual downtrend throughout the session.

The decline was attributed by the media to a new Redbox-Verizon streaming video service that will cost $6 per month (though with a smaller selection than NFLX), adding another competitor in the online streaming wars.  I think the reason for the decline was more technical, as the selling picked up in the afternoon after the stock breached the 200 day moving average around $78.50.

Yesterday’s move puts the stock back in the 50 to 80 range that I’ve highlighted before.  My NFLX trade in October profited from playing that range (and fortunate timing, closing it out before the Icahn headlines hit).  NFLX’s fall back into the range on decent volume yesterday instigated me to explore a similar trade this morning.  

First, here’s the 6 month stock chart for NFLX:



I’ve highlighted the 50 and 80 levels with horizontal lines in red, and the 200 day ma is downward sloping in black.  The inability of NFLX to escape this range for the second time in the last 6 months could provide an opportunity.

The ownership setup is interesting as well.  Some key points:

  1. Icahn now owns 10% of the company, while mutual funds and index funds own most of the balance.
  2. Icahn disclosure was not very convincing.  It was actually funny in its lack of detail.  I read it to say something like, “I like watching movies, and NFLX is the new medium for movies.”  His Chesapeake long so far has not worked well either, another controversial knife-catching exercise.
  3. Short Interest is still at 28% of float, even after the late October rally (down from 32% in October).  This is higher than I would have expected given the Icahn news.

In other words, you have a large, well-known buyer that caused the recent bounce, but he didn’t shake out many of the shorts, illustrating their conviction on the fundamental trends.

Fundamentally speaking, I do think Netflix is going to be hampered by increasing competition, especially since NFLX is constantly in need of new content, but now competing with big pockets.  Also, the stock still looks expensive based on analyst estimates for a turnaround.  But the bear-arguments are well known, and short interest is high, so I don’t think the stock craters by any means.

I’m talking myself into the range trade again.  Only one issue – implied volatility in Jan13 is in the low 50s, at the low end of its 1 year range.  I’d prefer Jan13 as it expires before NFLX’s next earnings announcement in late January.  Selling the at-the-money straddle, the Jan13 75 straddle, and buying the Jan13 65 / 90 strangle would only yield around $9.00.  BUT, if I wanted to take a bit more of a bearish directional view (and play the midpoint of my proposed 50 to 80 range), I could sell the Jan13 65 straddle, and buy the Jan13 50 / 80 strangle, and get a credit closer to $10.  That would be a pretty convicted view that the stock doesn’t get back above $80.

For now, I’m doing nothing.  If NFLX implied volatility sees a pop to closer to 60 in Jan13, then I might put on my range trade once again.

Markets overnight:

  • Asia traded mixed, with China up while most of the region was both sides around flat
  • Europe opened flat, but quickly traded green, now up 0.6%.  SPX futures flat
  • Dollar and Treasury bonds weaker, but surprisingly, commodities weaker as well, with gold and silver both down 0.75%, not what you’d expect with dollar weakness