More of us are now consuming video from online streaming sources rather from traditional TVs. This is good news for those providers, and currently there are none more popular than Netflix, Inc. (NASDAQ:NFLX). Though popularity doesn’t mean a mandate for ever-higher prices in NFLX stock.
Binge viewing has almost become a sport. I’ve been guilty of ripping through a full season of one show or another.
However, the popularity of online viewing attracted fierce competitors most notably Amazon.com, Inc. (NASDAQ:AMZN), Alphabet Inc (NASDAQ:GOOGL), Apple Inc. (NASDAQ:AAPL) and Facebook Inc (NASDAQ:FB). Traditional media is also making headway into the arena and they already have the content.
Netflix management already runs a high-cost structure to deliver the growth. I do worry for the long term though. I believe NFLX stock will not be able to deliver on Wall Street’s expectations. For now, they get a pass on profitability as long as the global growth carrot is still on the table.
Fundamentally, I’m not even going to try to justify the value of Netflix shares. It has a bloated price-to-earnings ratio of around 200 — that’s even higher than Amazon! Furthermore, there are big differences between the two which worsen the long-term viability of Netflix’s current cost structure. Management is stuck needing to maintain these high operating expenses for as long as it needs content — even though developing its own content is cheaper, it’s not a total fix.
And the real killer is cash. Unlike Netflix, Amazon has complete control over the cash it consumes so it can easily withstand periods of adversity. Netflix is vulnerable there.
Click to Enlarge While long-term I favor bearish outlooks for Netflix, for the short-term, dips are buying opportunities. Today, I will set a mid-term bullish trade in NFLX stock.
Just understand that this isn’t an endorsement — merely an acknowledgement that bulls will step in and support shares.
How to Trade NFLX Stock
The bet: Sell the Dec $110 put and collect $2.25 per contract to open. Here, we have a 85% theoretical chance that we will retain our maximum gains. However, if Netflix shares fall below the strike price, we’ll become owners and could accrue losses below $107.75.
To moderate the risk a lot, we can use a bull put spread instead.
The more moderate bet: Sell the Dec $110/$105 credit put spread. The spread could still deliver 13% in yield, even though the risk is smaller than that of a naked put.
The comparison I like to make? To match the performance of the spread, you’d need to buy NFLX stock outright, for $151 per share, with no room for error. Then you’d need that stock to rally 13%!
In either options case, I don’t need a rally to profit as long as price stays above $110 this year.
Selling options is risky, no matter how careful you are. So never risk more than we can afford to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
