The Netflix Stock Rally Has Finally Stalled – Here’s How to Profit

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Shares of Netflix (NFLX) are finally showing signs of fatigue, after doubling in price from the early April lows at the $60 level to more than $120 in early August following second-quarter earnings and vague takeover chatter.

Subsequent to making new all-time highs on August 5 at $129.29, shares of NFLX tumbled sharply, falling back to the pre-Q2 earnings breakout level of $97.50.

nflx-stock

The Netflix stock price eventually recovered, trading back up to to the $115.50 area, before falling back to the $97.50 support level following somewhat disappointing third-quarter earnings. Once more, Netflix stock rose off support to trade right up to the $115.50 resistance level before dropping back yet again.

In the chart below, I actually copied the two short-term trend lines to show the extreme similarity of the moves.

netflix-stock-price

Yesterday, news broke that competitor Hulu may be looking to sell a stake to Time Warner (TWX), which became the impetus behind a 3.5% drop in NFLX, as competition may be heating up. Amazon (AMZN), notorious for sacrificing margins at the expense of market share, is already in the space via Amazon Prime Video, so current margin levels for NFLX may be hard to maintain.

Most discussions on Netflix stock usually make mention of the lofty P/E multiple (290) and high content acquisition costs, which is certainly worth mentioning. For stocks such as NFLX, AMZN and other high-growth, high-multiple stocks, I prefer to take a more technical approach. I let the market tell me what it thinks of the stock.

In the case of NFLX, the market is now clearly defining what it deems to be the proper valuation area, with resistance at $115.50 and support at $97.50. With NFLX stock towards the upper end of that trading range, I am looking to structure a short call spread to position for a pullback to the middle of the this area.

How to Trade Netflix Stock

Using the monthly options that expire next week, sell the NFLX Nov $116 calls and buy the NFLX Nov $119 calls for a 40 cents net credit ($40 per contract). This positions the short strike just above the $115.50 resistance level, with maximum gain limited to the $40 net credit received. Maximum loss is $260 per spread, with return on risk of 15.38%.

I would cover the trade if NFLX shares break out meaningfully past the $115.50 resistance level; otherwise, let the position expire worthless and keep the initial premium.

As of this writing, Tim Biggam had no position in the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can e-mail Tim at tbiggam@deltaderivatives.com.

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Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, four years as Lead Options Strategist at ThinkorSwim and three years as a Market Maker for First Options in Chicago. Tim makes weekly appearances on Bloomberg TV  “Options Insight”, Business First AM “Trader Talk”, TD Ameritade Network “Morning Trade Live” and CBOE-TV “Vol 411” to discuss everything from volatility and option related.


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