Netflix, Inc. (NASDAQ:NFLX) reported earnings last night, and Wall Street so far likes what it saw. NFLX stock is rallying on the back of a big beat in subscribers. Investors are ignoring the critics, who point out that the cash burn and debt levels are less than ideal.
NFLX’s asset is its original programming. But that’s a double edged sword. On the one hand, it’s the carrot that is the magnet for subs. On the other hand, it’s a costly proposition that is the source of the financial criticism.
Technically, we’ve noted the upside potential in NFLX stock when we wrote about streaming profits for free just two weeks ago. The trade is a complete win and can be booked for profits. While I can’t argue with the notion that Netflix has its financial stresses, I can’t get on board with a complete collapse.
NFLX will have fierce competition from the likes of Amazon.com, Inc. (NASDAQ:AMZN). It also must worry about traditional media venues transitioning to online delivery. There could be other offers from tech giants: Apple Inc (NASDAQ:AAPL) recently announced that it will enter the original programming game. Other potential sleeping giants include Alphabet Inc (NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB).
However, for the mid-term, the moat that Netflix built should be deep enough that the company could continue to execute on its global expansion plans.
How to Trade NFLX Stock
Click to Enlarge Now that I have recent profits from NFLX, I will sell spreads that should range the company against levels that should not come into play in the next few months.
Think of it as me selling lottery tickets that should be losers for the buyers.
The trade: Sell the NFLX Jun $180/$185 credit call spread for 50 cents per contract. This trade has a 85% theoretical chance of success with a 11% potential yield. I need Netflix stock to stay under my sold spread through the expiration date.
I always like to balance my trades. In this case, I will simply do the opposite and sell some bullish premium. But I would delay entry just in case they want to take back some of the 9%-plus earnings pop.
The hedge: Sell the NFLX Jun $105/$100 credit put spread for 60 cents per contract. If successful, this trade would yield 12% on money risked. The 25% price buffer gives me a 90% theoretical chance of success. I need NFLX stock to stay above my sold spread through expiration.
Taking both trades would put me in a sold iron condor. If Netflix stays between both spreads sold, my yield would be 25%. Taking both trades also lowers my risk as I can only lose on one side or the other.
I am not required to hold either trade through expiration. I can close either at any time for partial profits or losses. Selling options is risky and should only be done if I am willing and able to absorb the potential losses.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
