Shop the Fire Sale in NFLX Options

by Tyler Craig | April 26, 2013 10:47 am

For its latest earnings release, Netflix (NASDAQ:NFLX[1]) donned its Santa Claus suit and delivered the best gift shareholders could ask for — a monster gap higher. And lest you think the 23.6% jump was a one-off event, keep in mind that shareholders of the popular media company received an even better present under the earnings tree in January when the stock soared 39%.

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Of course, this year’s good fortune for NFLX isn’t exactly driving it into uncharted waters. Quite the contrary — its story of 2013 has been one of resurrection after being left for dead following the five-month bloodbath in 2011 that took the stock down 80%.

NFLX shareholders who held through the 2011 crash are finally being rewarded — indeed, vindicated — for their patience. But they shouldn’t rest on their laurels. After all, Lady Luck is a fickle dame. NFLX bulls looking to cash in on their good fortune, or at least protect what they’ve regained, should consider harnessing the power of options.

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Following this week’s earnings report, the implied volatility on NFLX options plummeted to its lowest levels in over 18 months. As shown in the accompanying chart, IV30 is resting at 45%, which is both at the lower end of its range and lower than every other historical volatility reading (not shown) — a sophisticated way of saying NFLX options are relatively cheap. On sale. A bargain.

Here are two risk-reduction strategies for NFLX shareholders, made all the more appealing by the current fire sale on Netflix options:

The Protective Put

The protective put strategy involves buying one put option for every 100 shares of stock you own. Since the put option locks in the right to sell stock at a certain price, it ensures your ability to sell NFLX near these levels just in case it crashes back down in the coming months.

Consider buying the July 200 put for $12. For a mere 5.5% of the current value of the stock, you can lock in your right to sell NFLX at $200 for the next three months.

If you’re looking for longer-term protection, you could buy the September 200 put for $21.

The Stock Replacement Strategy

An alternate approach designed to drastically reduce the amount of capital tied up in the stock — while allowing you to continue to rack up gains if NFLX furthers its ascent– is the stock replacement strategy. The replacement involves selling your stock and buying a call option. Usually you buy one call option for every 100 shares of stock you own.

For example, you could sell your NFLX shares and buy a July 210 call for $20.50. The long call only ties up about a tenth of the capital necessary to hold 100 shares of stock. Your max risk has dropped from about $21,500 to $2,050. Plus, if NFLX continues to rise, you stand to score additional gains since the call option will appreciate in value.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

  1. NFLX:

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