Netflix, Inc. (NFLX) — NFLX stock is currently up more than 150% year to date. While the rally shows little sign of stopping from a pure price perspective, a closer look reveals some red flags that could allow active investors to initiate medium-term bearish bets.
When Netflix reported second-quarter earnings on July 15, the company beat estimates and showed impressive user growth numbers, as well as a bullish outlook. As a result, NFLX stock blasted 18% higher, and it continued its rally into last week on the back of analyst upgrades.
Besides the bullish outlook, there is another reason NFLX stock is surging. With the S&P 500 and other broader U.S. equity indices largely stuck in boring trading ranges, fund managers are being forced to chase higher the few single company growth stories out there, such as Netflix, Starbucks Corporation (SBUX) and Facebook Inc (FB). This is referred to as momentum chasing and almost always ends badly, at least in the near-to-medium term.
Let me make it clear that I am not bearish on NFLX stock structurally and, in fact, see it as a great growth story in coming years. It is simply the near-term slope of the chart that looks improbable to continue its ascent at this rate.
I often discuss that the most severe price corrections or mean-reversion moves happen to those stocks or markets that see an already steep ascent turn into a vertical blast higher. Over the years, NFLX stock has given us several of those types of moves. Each and every one has ended in a volatile corrective move that reset the chart and allowed it to once again rise from more neutral territory.
After a steep advance this year, NFLX stock took its chart vertical. Shares are now more than 40% above their 200-day simple moving average (red line). The MACD oscillator reached an all-time overbought extreme. Also note the rising wedge resolved to the upside, which often doesn’t last long before a mean-reversion move sets in.
There are two ways to play this:
1. Active investors that want to give this trade a little more time to breathe could consider selling out-of-the-money call spreads. Implied volatility has increased materially since the earnings report, but there are still opportunities to sell call spreads using October options.
2.More aggressive traders could initiate small short positions in the stock at current levels, using the low $130s as a stop-loss area and the $100 to $110 area as an initial price target.
