Trade Update – NFLX: Buffering

by CC May 20, 2014 12:08 pm • Commentary

NFLX is higher once again today, which is the 8th day out of 9 that the stock is green.  At this point, the likelihood of a quick drop to the $300 support level over the next month is quite low, especially since the stock has held yesterday’s breakout over the 50 day moving average.

So what do we plan to do with our current position?  

Well, we could simply sell the Jun21st 325/285 put spread at around $3.00, salvaging some premium vs. our initial $9.90 premium outlay.  However, with a month until expiration, and a good amount of overhead supply in the stock above $370, we’d rather transform the current position into a higher probability trade, without risking too much additional premium.  With that in mind, here’s the trade adjustment:

en and it involves turning the March 575 call into the upper wing of a butterfly. So here’s the adjustment:

ACTION- Buy to open the NFLX ($370.50) Jun21st 365/325 1×3 put spread, and buy the Jun21st 285 puts 2x, all for $5.30 debit

-Buy 1 Jun21st 365 Put for 14.25

-Sell 3 Jun21st 325 Puts at 3.45 each, or 10.35 in total

-Buy 2 Jun21st 285 Puts for 0.70 each, or 1.40 in total

New position is the Jun21st 365/325/285 put butterfly for $15.20 (currently worth $7.30)

New Break-Evens on Jun21st Expiration:

Profits:  gains btwn 300.20 and 349.80 of up to 24.80, with max gain of 24.80 at $325

Losses:  btwn 285 and 300.20 lose up to 15.20, btwn 349.80 and 365 lose up to 15.20 with max loss of 15.20 below 285 and above 365

Rationale:  This trade adjustment greatly improves our range of potential profitability (300.20 to 349.80 on June expiry, as opposed to below $315.10 with our old put spread position) given the recent rally in NFLX shares.  In exchange for that improved range, we have to spend an extra $5.30 in premium, and we also do end up giving up potential upside if NFLX shares trade significantly lower (below $310) over the next month.

We decided to adjust the position because the Jun21st 325 / 285 put spread has become a low probability structure that might not even make back much money given its decay if NFLX just grinds lower in the next few weeks.



Considering Our Options – NFLX June Put Spread

Netflix broke out of its 4 day consolidation from last week, blasting above its 200 day moving average (yellow line below) and heading straight to its declining 50 day moving average (purple).  This is obviously a fairly important technical spot for the stock as a hold above $350 (red) would put the possibly of a positive outcome for our bearish trade very low:

NFLX 6 month chart from Bloomberg
NFLX 6 month chart from Bloomberg

On Friday in a Chart of the Day post we suggested:

The longer NFLX stays below the $350-$360 resistance area, the more likely a retest of the $300 support level becomes.

Since we wrote those words the stock has bounced $20 in almost a straight line causing us to rethink a $350 re-test in the very near future without some fundamental impetus.  While we remain bearish on the company as the competitive landscape will only become more challenging in the coming months, the price action today leads us to call into question our entry of the trade. Therefore if the stock is able to hold this 50 day moving average it likely means the stock is staging a healthy rebound off of recent lows and we’d look to take the trade off for a loss before it becomes worthless. If the stock gets rejected here we would be more inclined to give the trade a couple more days and see if it can hold $350.




New Trade – Netscape, I mean Netflix (NFLX)

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 Netscape 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.