Use a Butterfly Spread to Catch NFLX Stock

by John Kmiecik | January 24, 2014 8:47 am

Some stocks’ earnings reactions can be downright shocking, if only because some details that many investors might find innocuous can still illicit dramatic moves in the stocks. The following trade idea focuses on Netflix (NFLX[1]), which had quite the dramatic move itself following its earnings report.

Netflix ($NFLX — 388.72): Butterfly Spread

The trade: Buy the NFLX Jan 31 390/400/410 call butterfly spread (buying the Jan 31 390 call and selling a pair of Jan 31 400 calls and buying the Jan 31 410 call) for $2.40 or less.

The strategy: The maximum potential profit for this trade is $7.60 if NFLX stock is trading right at $400 at Jan. 31 expiration. The long 390 call option would have $10 worth of premium and the other options would expire worthless. Then the cost of the trade is subtracted ($10 – $2.40). The maximum loss is $2.40 or what was paid for the spread if NFLX stock is trading below $390 (all options expire worthless) or above $410 (all options would have to be bought or sold) by expiration. Breakeven is at $392.40 and $407.60 at expiration based on a cost of $2.40.

The rationale: Netflix just announced earnings and it seems market participants liked the results. NFLX stock gapped considerably higher after the company projected customer growth that easily beat analysts’ estimates. Netflix estimates that it will acquire about 2.25 million new domestic subscribers and also predicted its Q1 profit will rise more than previously expected. NFLX spent considerably more on domestic marketing than it normally does in the last quarter, and it apparently believes it has worked because it has raised their guidance going forward.

Click to Enlarge The $400 level was chosen for the body of the butterfly (max profit area) because of the potential for some resistance at that level. Sometimes a stock will find resistance or support at round numbers; in the case of NFLX stock, that round number is $400. Netflix also is trading at all-time highs.

As mentioned above, Netflix stock gapped up by more than 16% Thursday after earnings were announced the previous evening. If the momentum can continue for Netflix into next week, this directional butterfly spread may have a good chance to profit.

The beauty of this trade idea is that it gives the option trader a fairly wide area to profit, provided NFLX stock it moves higher from where it is currently trading. The key is to not have NFLX move too high before expiration.

Hunker down and watch some movies this weekend[2], and hopefully by next week, this trade will be able to help pay for some of your Netflix subscription fees.

As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities. Get a free trial of John’s live options trading room here[3].

Source URL: https://investorplace.com/2014/01/butterfly-netflix-inc-nflx/

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