Options Plays for a Resurgent Netflix

by Joseph Hargett | July 6, 2012 8:51 am

The shares of online video rental/streaming firm Netflix (NASDAQ:NFLX[1]) have been on fire this week. Since July 3, the stock has soared more than 20%, eclipsing former resistance at its 50-day moving average in the process. The last time NFLX closed above this long-term moving average was March 29.

While the stock was already trending higher during this holiday-shortened week, investors flocked to snatch up NFLX shares on Thursday after CEO Reed Hastings announced that Netflix subscribers watched 1 billion hours of content[2] in June. For comparison, Netflix subscribers watched a total of 2 billion hours during the fourth quarter of 2011.

“When House of Cards and Arrested Development debut, we’ll blow these records away,” Hastings said in a post on Facebook (NASDAQ:FB[3]). The company will launch House of Cards later this year, while new episodes for the cult-hit Arrested Development will debut in 2013.

Despite the stock’s surge, analysts remain unconvinced that NFLX is worth the run higher. In fact, Wedbush analyst Michael Patcher told Reuters that the increased viewing time could lead to increased costs for NFLX, which is a negative for the company if it doesn’t raise prices to compensate. “Wall Street has this one wrong. It’s a perverse reaction, and they have it a hundred and eighty degrees wrong,” said Patcher.

Patcher is far from alone in his bearish assessment. According to data from Thomson/First Call, only eight of the 33 brokerage firms following NFLX rate the shares a buy, compared to 17 holds and 9 outright sell ratings. What’s more, the average 12-month price target rests at $95 — a premium of only about 16% to the stock’s close at $81.72 on Thursday.

There’s also a fair amount of negativity still present among the short-selling community. In fact, during the most recent reporting periods, the number of NFLX shares sold short rose 6.7% to 14.13 million. As a result, more than 24% of the stock’s float, or shares available for public trading, are now sold short. Should the stock continue higher, it could force these short sellers into covering their bets, creating a potential short-squeeze situation.

From a contrarian perspective, there’s potential for additional gains, but traders may want to exercise a bit of caution when trading NFLX options. Those looking to bet on a continued bull run higher might want to consider a July or August 80/90 bull call spread.

The August 80/90 spread was asked at $4.10, or $410 per pair of contracts, as of the close of trading on Thursday. Breakeven for this trade lies at $84.10, while a maximum profit of $5.90, or $590 per pair of contracts, is possible if NFLX closes at or above $90 when these August options expire.

An alternative strategy would be to enter a bull put spread. With NFLX’s 50-day moving average hovering just above $70, an August 67.50/70 bull put spread has a good chance of expiring out of the money. At the close of trading on Thursday, this spread was bid at 68 cents, or $68 per pair of contracts.

The maximum profit for this trade is the net debit received upon initiation, while the maximum loss arrives at $1.82, or $182 per pair of contracts, if NFLX closes at or below $67.50 when August options expire.

Endnotes:
  1. NFLX: http://studio-5.financialcontent.com/investplace/quote?Symbol=NFLX
  2. Netflix subscribers watched 1 billion hours of content: http://investorplace.com/2012/07/netflix-reaches-major-streaming-milestone/
  3. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB

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