Update – Netflix (NFLX) Overlays vs Stock

by CC April 17, 2018 2:39 pm • Trade Updates

Yesterday we preview Netflix’s (NFLX) q1 earnings and detailed two trade ideas for those long the stock. One added leverage for a move higher in line with the implied move higher, the other was a hedge in case the stock dropped, with a call sale near the expected move higher. Both were available for even money. With the stock higher in line with the expected move but with expiration on both overlays a few days away, let’s check in on both and see how to manage each. First, the leverage. Here was the trade idea:

Trade Idea vs 100 shares of NFLX long at $309, Buy the Apr 20th 325 / 340 1×2 call spread for even money

-Buy to open 1 Apr 325 calls for $7

-Sell to open 2 Apr 340 calls at $3.50 each or $7 total

With NFLX 337 this overlay is worth about 5.70. Combine that with the $28 gained in the stock and that’s a nice little trade. But as far as trade management goes, it could be worth more. Right now it is worth $12 intrinsically, meaning, if the stock closed at 337 on Friday, the trade will have added $12 in additional gains. Of course, if the stock were to rip higher it could go through that short strike, but that’s not the worst thing in the world. This trade is long delta and its gains would improve as it goes higher (along with more gains in the stock). The point where it starts hurting isn’t until much higher (it would be worth less than $5.70 if the stock closed at 349.30 or above) In other words, if the stock continues higher over the next few days this trade will continue to help, even slightly above the short strike.

On the flipside, if the stock were to decline over the next few days the gains in the stock would decrease, but for the overlay, it has some room on the downside too where it would be worth more on Friday than it is today. Any close above 331.70 and the overlay will be worth more than it is now. So that should be used as a stop on the downside. Of course, all of this assumes a desire to hold onto the stock after Friday.

Now let’s take a look at the hedge and see how much it hurt. Here was the hedge overlay:

Trade Idea vs 100 shares long of NFLX at $309 Buy the Apr 335 / 282.50 Collar for even money

-Sell to open 1 Apr 335 call at $4.40

-Buy to open 1 Apr 282.50 put for $4.40

With NFLX 337 we are now above the short call strike and the hedge has cost about 6.75 of the $28 gains in the stock. Not only that but if the stock closes above 335 on Friday the stock would be called away. Assuming that’s not the intention wiggling out of this hedge for the least hit on the profits in the stock by Friday should be the game plan. Intrinsically this hedge would only cost $2 with the stock here on Friday, that wouldn’t hurt much at all against $28 in gains. So that means that even if the stock went higher by a few dollars between now and Friday, the hedge would actually cost less than it is currently costing mark to market. Therefore a (very tight) stop to the upside of 341.75 makes sense near term (even into the close) and at some point you just take this off for the least cost possible. On the flipside, if the stock pulls back a few dollars and closes below 335 on Friday the hedge would expire worthless and wouldn’t cost anything versus the gains in the stock. But if the stock remains higher than 335 the short call needs to be closed in the next day or 2 so that it doesn’t get assigned on Friday.