While markets struggled in 2015, Netflix, Inc. (NFLX) stock was a star performer. Bulls were attracted to its potential growth from global expansion.
Yes, its high valuation always puts NFLX stock on most hot lists of stocks to short for many experts, but so far, that has been a painful trade.
I want to short NFLX … but not based on valuation. I see trouble coming from Amazon.com, Inc. (AMZN) in 2016, and I believe we could see an epic battle between two giants.
I believe AMZN under the leadership of Jeff Bezos will make headway into the streaming and movie arena. This will undoubtedly inflict enough damage that Netflix will need to adjust its formula to survive the assault. If I am right, NFLX will have to contend with a company that has squashed its competitors in almost every industry it entered.
Amazon is a fearsome competitor.
And given that NFLX is a momentum stock, I will use the options market to set my trade.
Trade on NFLX Stock
Click to Enlarge Options are time-sensitive, so I want to set enough time on my trade to better manage the risk.
I first looked at this in late December. I chose the Feb 16 $110/$105 debit put spread for a net cost of $1.85 per contract when I first entered the trade. This would be the max possible loss. If NFLX stock falls past both legs before the expiration date, I stand to gain $3.15 per contract.
The trade currently sits at $2.89 per contract, so anyone jumping in now would make $2.11 per contract.
There are at least two modifications that I could do to better manage my risk:
- I can turn this short NFLX stock idea into a pair trade by creating income from credit put spreads in AMZN. But this would leave me open to possible losses if AMZN falls to the sold strike puts.
- I can set the trade farther out in time adding time to the clock to prove the thesis right.
Since my original setup of the trade, markets fell, making the trade a big winner already. But I still believe my thesis remains viable as originally designed last week, hence the updated numbers. These and other headwinds should better my odds of success with this short idea.
Helping the bearish trade are market jitters from a sharp rise in China equity market uncertainties. This is likely to continue throughout the first quarter of 2016. Later this quarter, we also are likely to hear talks of fed funds rate hikes.
I do believe in Netflix as a viable company, but NFLX stock came too far too fast in 2015. This year is likely to be difficult for the market in general, and Netflix stock won’t be excused this time.
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.
