Trade Ideas January 21, 2020

Netflix (NFLX) Q4 Earnings Preview

by Dan

Netflix (NFLX) will report its Q4 results tonight after the close. The options market is implying about a $27 move or about 8% in either direction tomorrow, which is rich to the average one day move over the last four quarters of about 4.5%. With the stock at $338, the Jan 24th weekly 337.50 straddle (the call premium + the put premium) is offered at $27, if you bought the straddle, and thus the implied move, you would need a rally above $364.50 or a decline below $310.50 to make money. But if you are looking to express a directional move while also defining your risk, you could merely buy the at the money call or put for about $13.50 and your max risk would be about 4%, very near how much the stock has moved on average over the last four quarters. But as regular readers know, you need to get a lot of things right to merely breakeven buying weekly options into events like earnings, without a healthy dose of conviction and a little luck, the likelihood of getting direction, magnitude of the stock move and timing right to yield a large return, relative to the risk are not great.

Sharted of NFLX are up 4.5% on the year, basically in line with the Nasdaq, but interestingly, after rallying 33% from its 52-week lows made in September, the stock has paused at an important technical level, near support from the first half of 2019 that the stock blew through following disappointing Q2 subscribers.

Interestingly, the implied move of $27 puts the stock below technical resistance in the $370s and above support near $310ish,

It is worth noting that backing the chart out a bit to a 5 year and you see a pattern forming a series of lower highs and a series of higher lows, which is likely to resolve itself one way or another in a big way once the tension becomes too tight but that seems like a little ways off at the money below the downtrend, and well off of the uptrend:

 

There has been a ton of talk about competition coming for NFLX for years… well, it is finally here, which is one reason the stock has not made a new high since early 2018. I think the most important aspect of that competition is that it is from wildly profitable companies who are also basically giving their services away for free for the first year (see Apple’s promo with iPhone purchase for a free year of Apple + and Disney’s promo with Verizon customers). I guess the most important part of this competition to my mind is that all of the content from other studios, which NFLX built a good bit of their subscriber base is going away. Not to mention how much it costs NFLX in cash-flow terms to continue to make new content, and I just don’t see how this game of musical chairs ends well for them. We discussed last week on CNBC’s Fast Money program:

 

My View: I am obviously not bullish on NFLX’s prospects longer-term, Could the company post better than expected subs, and guide to lower than expected negative cash-flow related to content creation and acquisition? Sure, would the stock rip on that to the tune of 8%? maybe as shorts might trip over each other to cover.

It will be interesting to see how NFLX would trade near the downtrend above, I suspect longs might take the opportunity to see and then it might set up well for a trade back to the longer-term uptrend just below $300.

So what’s the trade?

If I were bearish I might consider calendar put spreads, looking to sell short-dated out of the money put premium near the implied move, and use the proceeds to help finance the purchase of a longer-dated out of the money put of the same expiration… this strategy would play for a down move near-term, but allow me to “leg-into” a longer-dated bearish position, for instance:

Bearish Trade Idea: NFLX ($338) Buy Jan 24th weekly / April 310 put calendar for $10

-Sell to open 1 Jan 24th weekly 310 put at $3

-Buy to open 1 Apr 310 put for $13

Break-even on Jan 24th expiration: if the stock is above 310 then the Jan 24th put would expire worthless and left owning the April 310 put for $10. The best-case scenario is that the stock closes at 310.01 and the April 310 put will have gained considerable value as it will have gained deltas and at that point the April put could be spread by selling a lower strike put in April expiration making a vertical put spread, further reducing the premium at risk. The max risk of this trade idea is the $10 in premium paid or about 3% of the stock price, and this in the near term would only be at risk this week on a sharp move higher or a move significantly below the $310 strike, which seems fairly unlikely.

 

Or If I thought the company might post a beat and raise I might consider call spreads in Feb expiration, allowing some time for follow-through to the upside.

Bullish Trade Idea: NFLX ($338) Buy Feb 350 – 375 call spread for $7

-Buy to open 1 Feb 350 call for 12

-Sell to open 1 Feb 375 call at 5

Break-even on Feb expiration:

Profits of up to 18 between 357 and 375 with max gain of 18 above 375

Losses of up to 7 between 350 and 357 with max loss of 7 below 350]

Rationale: the best reason for a trade idea like this (considering my disclaimer above about short-dated long premium directional trades into events) would be defining your risk if you think it is going higher and using options implied move and technicals to help guide the trade. The risk-reward of $7 vs potential $18 gains is just ok. The options market is saying there is above a 35% chance this trade is in the money (break-even) on Feb expiration and about a 22% chance that it is worth its full value. So again, one would need to be convicted on a short term move higher to even consider such a trade.

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