Quarterly earnings are just starting to accelerate this week with several big-name stocks announcing. So far, there have been a few surprises, with a couple of familiar names moving lower after reporting, including Goldman Sachs Group Inc (NYSE:GS) and International Business Machines Corp. (NYSE:IBM) The one familiar stock I want to focus on today however is Netflix, Inc. (NASDAQ:NFLX) for the reasons I will discuss below.
Just recently, Luke Lango wrote about how investors need to look past certain numbers when it comes to NFLX and focus on what is important. He thinks the company’s changes — including cutting some original content, which has led to more profitability — could impress investors over the long haul.
Lucky for us, this trade idea on NFLX stock is not meant for the long haul.
But before we go any further, let’s talk a little bit about an option strategy that I frequently consider. It is a vertical call credit spread. Essentially, it is a bearish trade but it does have some special nuances to it. Depending on how it is implemented, the strategy can profit if the stock moves lower, stays the same or even moves higher. The ability to profit in this caliber is what gives options an advantage over other trading vehicles in my opinion.
Let’s take a look below.
An Option Strategy for NFLX Stock
The rationale: This trade idea is built upon the idea that Netflix won’t move decisively higher. What better than to have multiple potential areas of resistance in its way, then?
Taking a look at the chart just below the stock is currently trading below its 50-day simple moving average. Moving averages are often considered form of support, and in this case potential resistance. In addition, the stock has twice tested the $148 area — which was close to its all-time high ($148.29) — and failed. This might be an additional potential resistance area for NFLX stock in case it does try to move higher before the options expire.
What could help this trade idea profit even quicker is a move lower. Netflix stock has now traded down to a potential support area at $140. This area has kept the stock from moving much lower after gapping above the area in the middle of January.
But just because support has a better chance of holding Netflix stock up for the time being, doesn’t mean that it will bounce and move much higher again.
The Trade: Sell the May $150 call and buy the May $155 call for a credit of 50 cents or more.
The Strategy: The maximum potential profit for this trade is 50 cents if NFLX stock is trading at or below $150 at May expiration. Both call options would expire worthless. The maximum loss is $4.50 ($5 – $0.50) if NFLX is trading at or above $155 at May expiration. Breakeven is $150.50 at expiration based on a credit of 50 cents.
Why would an options trader risk nine times what they are willing to make?
The odds. With the current delta of the short call at the time of this writing at around 0.18, many option traders will say the option has an 18% chance of expiring in-the-money (ITM). That means based on the “option trader’s definition” of delta, there is an 82% chance of the option expiring out-of-the-money (OTM) and worthless leading to max profit.
Like I mentioned above, the stock can move lower, sideways and higher as long as it does not close above the breakeven point at option’s expiration. And you can consider exiting this position ahead of expiration
John Kmiecik is the head options instructor for Market Taker Mentoring, and co-author of the eBook 3 Secrets to Making Money in Any Market. Get your complimentary copy of his option trading eBook here. He can be reached at firstname.lastname@example.org. At the time of this writing, he did not own a position in any of the aforementioned securities.