Netflix, Inc. (NASDAQ:NFLX) shares have rallied a huge 18% off their May 12 lows, but now they’re starting to get a little exhausted. As a result, we should look for NFLX stock to start to give back some of these recent gains over the next few weeks.
Technically, Netflix stock still hasn’t broken out above the recent downtrend line, with the stock peaking at the $104 level on May 26. So until NFLX can convincingly pierce through through the downtrend line, shares likely will continue to struggle.
Netflix also has run into some major gap resistance at current levels, as seen in the chart below. These gaps equate to the $102 to $107 level in NFLX stock and will continue to provide some formidable overhead technical resistance.
Implied volatility (IV) is also at trough levels, currently residing in only the 9% percentile. Low levels of IV indicate extremes of complacency, which usually equates to near-term tops in the price of the underlying stock. The last time IV was this low in NFLX stock marked a significant top.
In a recent article on Netflix from April 20, I opined that NFLX stock might be due for a bounce — and that did come to pass. With the subsequent sharp rally in NFLX shares, though, my opinion has changed from somewhat bullish to somewhat bearish, because price does matter.
More importantly, price action matters, and the recent price action in Netflix shares is pointing to a period of consolidation.
With implied volatility at comparatively low levels, I want to structure a trade that is long volatility, so a put diagonal trade makes intuitive sense to me. By selling a lower strike price than the one I am buying (hence the diagonal part), I can take a slightly more bearish stance while still defraying some of the time premium decay with the option I am selling.
Trade Idea on NFLX Stock
Buy NFLX July $100 puts (expire 7/15/16) and sell the NFLX June $99 puts (expire 6/17/16) for a $3 net debit. (Both options used to create the spread are the regular monthly options.)
The initial trade is 8 deltas net short, so it’s slightly bearish in nature.
Ideally, NFLX stock closes near the $99 level at June expiration to achieve the maximum profit.
The risk is limited to $300 per spread.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
