New Trade – Netscape, I mean Netflix (NFLX)

by CC May 6, 2014 11:41 am • Commentary

Netflix is down more than 20% from its early March high.  Despite that beating, the stock is only down 7.5% year-to-date, and actually still up 70% over the last year.

Dan executed a very nice fade trade of NFLX after its earnings gap higher in April, taking it off for more than a double.  As Dan wrote 10 days ago, we think the Greater Fools Parade is over in many of the high fliers.  As the momentum stocks get hit, we’re watching the technicals quite closely for spots to re-enter broken trades.

Well this morning, NFLX has rallied back up to its 200 day ma, where it is finding some resistance:

NFLX daily chart, 50 day moving average in pink, 200 day moving average in yellow, Courtesy of Bloomberg
NFLX daily chart, 50 day moving average in pink, 200 day moving average in yellow, Courtesy of Bloomberg

While the current rally does not look like much on the daily chart, NFLX has actually rallied more than 10% since its April 28th low just below $300.  The ideal spot to fade the current strength would be at the declining 50 day moving average, which is now around $380.  But we don’t think NFLX gets up there, and the recent move higher is another opportunity to fade NFLX strength in our view.  Of course, with implied volatility above 40, the options structure we choose is important too.

Why pick on NFLX again?  Well, the technicals are bad, but we also view the fundamental backdrop for NFLX as much more concerning than most Internet stocks.  First, the company is running into increased competition on multiple fronts (AMZN / HBO deal, recent AT&T / Chernin group deal).  NFLX has first mover advantage, but its huge content costs leave it quite vulnerable.

Which brings us to the second, and more crucial point.  NFLX’s recent deal with Comcast was a sign of capitulation in our view.  Comcast won, and NFLX lost, plain and simple. Netflix is Netscape, they just doesn’t know it yet.

Between the net neutrality rulings and everyone moving into their market, NFLX will probably go down in history as a first mover that eventually got overtaken by the big boys it once threatened.

Comcast (and others) control the operating system on our televisions just as Microsoft did on our PCs in the 90’s. What that means is the big boys can wait for threats to their business models like Netflix represents to Comcast (the threat is cord cutters) and then give away a clone of that threat on their own system for next to nothing or free until the threat is gone.

In this comparison, Xfinity x1 = Windows, Streampix = Internet Explorer and Netscape = Netflix.

Netflix is a great product (although their streaming movie library, like everyone else at this point, is pretty sparse), but how on earth is it going to compete with Comcast giving away a similar product for 5 dollars a month (why Streampix isn’t free and bundled with X1 already is a mystery), and Amazon giving away a similar product bundled with their Amazon Prime service?

Comcast and Amazon have the chance to do to NFLX what MSFT did to Netscape in the 90’s. And others will join the fracas. None of this is good for NFLX in the long run. You have to give them credit, they realize the threat and are doing everything in their power to fight it with original content like House of Cards.

It’s a little sad because the great first movers like Netscape and Netflix deserve a better fate, but we know how this story ends.

(Read about the browser wars here)

So what’s the trade?:

NEW TRADE – NFLX ($338.30) Bought June21st 325 / 285 put spread for $9.90

-Bought 1 June21st 325 Put for $13.71

-Sold 1 June21st 285 Put at $3.81

Break-Even on June21st Expiration:

Profits: btwn 285 and 315.10 make up to 30.10, max gain of 30.10 at 285 or lower

Losses: btwn 315.10 and 325 lose up to 9.90, with max loss of 9.90 above 325


Rationale:  We don’t expect Netflix to turn into Netscaape overnight and like everything in tech no comparison is exact. And when doing a trade with a few month time horizon, long term trends don’t seem to matter. But when the tide has turned in stocks like this, which we believe it has, everyone seems to get it all at once. And suddenly everyone was the guy that realized Netflix’s business model was doomed after the fact.