Netflix (NFLX) and Gap Fill?

by Dan October 16, 2018 2:21 pm • Trade Ideas

Yesterday I previewed Netflix’s (NFLX) third-quarter results due out in a couple of hours (read here) and discussed my Options Action co-panelists Cater Worth’s bearish technical take on the stock and Mike Khouw’s defined risk bearish options trade idea that corresponded, while also adding my own hedge idea for long holders.

Shares of NFLX are up nearly 2.5% today, and up 8% from Thursday’s nearly two-month low, yet still down nearly 20% from its all-time high made in late June. The hedge idea that I detailed yesterday was an effort to offer long holders a way to lock in a good portion of the stock’s now 78% gains on the year, while Mike and Carter’s bearish trade idea could also be used as a hedge, it was a defined risk way to play for an earnings disappointment followed by a move back to technical support.

Regular readers and viewers of Fast Money and Options Action are aware of the fact that no matter how bullish or bearish I am on an individual story, I don’t like to press a big move one way or the other into an event like earnings. Last week on Fast Money I was asked whether strong earnings could help stabilize specific stocks that have dramatically underperformed the broad market of late and my answer was quite simple. When a stock is in correction mode into earnings it will take something well beyond the already poor sentiment for the stock to react in an extremely negative way. Translation, it is very hard to press shorts that have performed poorly in a good tape into earnings and on the flip-side, it is very hard to press a long that is up on a spike into earnings.

SO back to NFLX, we have a bearish trade from Khouw and Carter, a hedge for longs from me, now it makes sense to detail a bullish trade for those who think the company will reverse last quarter’s subscriber disappointment and print results that will cause shorts to scramble to cover.

While I don’t usually like short-dated long premium trades into events like earnings, with NFLX down nearly 20% in the last few months, and sentiment poor, it might make sense to look at the Oct 19th weeklies and risk what you are willing to lose if bullish.

With the stock at $341.50 the Oct19th 342.50 straddle is offered at $34, if you bought the implied weekly movement you would need a rally above $376.50 or a decline below $308.50 to make money, or nearly 10% in either direction. But if you had a convicted directional view the at the money put or call is a little less than 5% of the stock price.

If I thought the stock could be up 10% tomorrow after strong results I might consider the following trade idea:

Bullish Trade Idea: NFLX ($341.50) Buy Oct 19th 350 – 380 call spread for $10

-Buy to open 1 Oct19th 350 call for $12.50

-Sell to open 1 Oct19th 380 call at $2.50

Break-even on Oct19th expiration (Friday):

Profits of up to 20 between 360 and 380 with max gain of 20 at 380 or higher.

Losses of up to 10 between 350 and 360 with max loss of 10 at 350 or lower.

Rationale: this trade idea breaks even up at 5%, half the implied move, and has a max gain up 11%, slightly above the implied move, risking 3% of the stock price. The options market is saying there is about a 45% chance the 350 calls are in the money on Friday’s close, but only a 33% chance that the trade will be at break-even on Friday’s close at $360. These probabilities are important when deciding to risk capital into potentially binary events like earnings with weekly options as you need to get a lot of things right to merely break-even, direction first and foremost, the magnitude of the move and of course timing.