I’m not winning any popularity contests with this article. The last time I recommended shorting Netflix, Inc. (NFLX), I was mocked mercilessly. Luckily, I ended up with the last laugh: I caught a drop from $110 per share to $80. So be kind with your feedback, just in case I get lucky again.
Today’s short is not speaking against the worth of Netflix as a company. Today, I want to challenge yesterday’s 4% spike on a headline that Apple Inc. (AAPL) could buy Netflix.
The rumor came from a different headline involving Apple and Time Warner Cable (TWC). One Apple executive mentioned TWC as a target, but no one else at had any interest. Yet, traders somehow extrapolated from this that Apple could indeed buy Netflix, despite it never being mentioned in the article.
Fundamentally, I think that Netflix is a leader in an exciting arena. Its global growth prospects are promising, but I predict that it will face tremendous pressure from the likes of Amazon.com, Inc. (AMZN) and the many other media giants. Amazon has a habit of exerting extreme pressure on its competitors’ P&Ls. If that happens, NFLX stock will suffer as valuations are always in question.
Click to Enlarge NFLX stock is down 10% year-to-date, but this is still 16% for the past year. So there is plenty of potential downside should the tide go against the stock. It has recently embarked on a breakout and now faces another potential descending line.
Trade #1 – The short: Buy NFLX Jun $100 put. This is a bearish trade for which you pay $2.50 per contract. Profits rise as NFLX stock price falls toward the strike price before expiration. These puts accumulate faster profits below $100 per share. To limit your exposure, sell a call to finance the put. This opens risk if Netflix rallies more than 40% from these levels this year.
Trade #2 – The bank: Sell NFLX Jan $142.80 call. This is also a bearish trade for which you collect $2.7 per contract. You risk losses for if the stock price rises higher than $142.80 through January. You can modify this trade to limit the upside risk exposure. Instead of selling the naked call, sell the Jan $148.57/$150 credit call spread and collect 13 cents per contract. Collecting premium reduces entry cost, thereby increasing the chances of success.
Netflix is an emotional stock. Its investors are too in love with the company, which spills over into the Netflix stock. I get better results when I trade without emotions. A 4% spike on a questionable headline is overkill, especially considering it came following a nice recent rally.
The pair trade described here is a way to go short NFLX without any out-of-pocket expense. I’m not obliged to carry any of these trades through expiration and can close any of them for partial profit or loss.
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.