Netflix, Inc. (NASDAQ:NFLX) is a popular service, but it runs its operation with a strenuous cost structure. The company pays a high price to deliver this ubiquity.
To make matters worse, formidable competitors are catching up and some run on even thinner margins. Mainly, Amazon.com, Inc. (NASDAQ:AMZN), which is a fiercely lean and mean foe. Also, Alphabet Inc (NASDAQ:GOOGL) isn’t afraid to spend heavily to deploy new ventures. Lastly, let’s not forget about Facebook Inc (FB), which has the full attention of billions of active users.
All of this cannot be good news for NFLX stock. Yes, it dominates now, but usually when you are at the top the downside risk is grave.
This is likely to be a longer-term risk, however, so set your feelings aside and trade the price action staring us in the face right now. Case in point, this NFLX trade that delivered income out of thin air.
Sometimes it pays to go long others’ opinion of a stock rather than the stock itself. While I don’t have much faith in the long-term future of NFLX stock with its current cash burn and expense structure, I do have gobs of faith that its fans will buy Netflix shares on every dip.
Click to Enlarge Technically, Netflix stock is now just above a consolidation level from where it recently leapt to the new highs. Neither bulls nor bears are usually willing to let such pivot points go without a fight. Meaning we could see a stalemate soon. This is perfect for selling premiums to generate income.
NFLX critics make good points, but for the short term, Wall Street chooses to give management a pass due to the potential of its global expansion theory. The problem for the bears is that this thesis has a long shelf life. Meaning it is likely to linger for a while before fizzling. And therein lies the support.
I am willing to bet that if Netflix stock falls, bulls will step in to support it. Else, I would be willing to own it myself. If I am correct, then I would generate income out of thin air. If I am wrong and price goes against me, then I would own the shares at a steep discount for current levels.
The Trade: Sell the NFLX Sept $115 put and collect $1 to open. Here I have a 90% theoretical chance of success. But if price falls below my strike then I have to own the share. I would also accrue losses below $114.
Even with a 20% price buffer, selling naked options carries large open-ended risk, so to mitigate risk I can use spreads instead.
The Milder Version: Sell the NFLX Sept $120/$115 where the risk is finite. Yet, with the same odds I can yield 9%. Compare this with buying the shares at face value while hoping for a 9% rally just to match the performance of this spread.
That said, selling options is risky, so I risk only what I can 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.