The denizens of Wall Street are prepping for tonight’s latest earnings release from one of last year’s biggest winners: Netflix (NFLX). The Internet television provider led the charge in 2013, climbing as much as 300% amid a sea of rising optimism for U.S. stocks. Although NFLX stock has seen a rather lackluster start to the new year, tonight’s Netflix earnings release should set the tone for the lofty momentum darling for the coming months.
Let’s see how the options market is pricing in expectations ahead of the big event.
At first blush, it appears market participants aren’t all that fearful of tonight’s conference call. In fact, volatility expectations are the lowest they’ve been heading into any Netflix earnings announcement in the past two years. The average implied volatility levels before prior announcements has been in the mid-70s.
This go around, however, implied volatility for NFLX stock hasn’t even risen above the mid-50s.
The abnormally low pre-earnings volatility level means that option sellers aren’t receiving near as much premium for selling options into the number. On the flipside, it means option buyers are able to snatch up options for much cheaper than usual.
To determine just how much of a gap is expected in the stock following Netflix earnings tonight, we can use the price of a weekly January straddle set to expire this Friday. With NFLX stock trading at $330, the 330 straddle — which consists of buying the Jan 24 330 call and the Jan 24 330 put — costs approximately $34. Since the options straddle is pricing a 10% move in the stock over the rest of the week, the expectation for how much NFLX stock will move directly after tonight’s earnings announcement is less than 10%.
Traders looking for a tame reaction to earnings tonight will want to sell volatility ahead of the number.
Consider selling an iron condor with February monthly options. You could sell the 390-395 bear call spread and the 270-265 bull put spread for a net credit of $1.10. The max reward is limited to the initial $1.10 credit received and will be captured if NFLX remains between $390 and $270 by Feb expiration.
If you think the volatility expectations are a bit too low and that NFLX stock is set to surprise with a big gap, buy a 330 straddle using the January weekly options expiring Jan. 31. The cost and max risk is $36.30. The potential reward is unlimited. If NFLX stock jumps more than 10% during the next couple days, the straddle should come out a winner.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.