Netflix, Inc. (NASDAQ:NFLX) recent fell 12% from its July high. This qualifies as a correction per Wall Street standards, yet not many experts are pounding the table to buy the dip. This is because NFLX is a momentum stock and these tend to run fast. So few traders are eager to overtly make judgement calls.
Momentum stocks present a quandary for most traders. On the way up they perpetually seem ready for a drop. But on the way down, they look like falling knives and not many would dare to attempt to catch them until it’s too late.
Today, I am sharing a relatively safe way to buy the dip in the downside momentum in NFLX stock. For that I will use NFLX options instead of buying the shares.
Fundamentally, NFLX is not cheap. It runs a 200-plus price-earnings ratio, which is in Amazon.com, Inc. (NASDAQ:AMZN) territory. For perspective compare it to Walt Disney Co (NYSE:DIS) which runs a PE under 20. I mention Disney because of the recent headlines they’ve made pertaining to cutting off and competing with NFLX.
DIS’s move was expected, but I don’t believe it will actually impact Netflix’s bottom line for a while. I’ve been on record before noting that Netflix will suffer on the hands of its competitors, especially Amazon. But for now, Wall Street gives NFLX a pass based on their perception of global expansion.
This morning, Apple Inc. (NASDAQ:AAPL) announced plans to spend a billion dollars shopping around Hollywood for content. Competition for Netflix is getting fiercer by the minute and eventually it will catch up with the NFLX stock price.
Click to EnlargeSo for now, I trade the shorter term technicals. Netflix stock range is tightening and a move should ensue. No one knows which direction NFLX shares will ultimately trend, but this morning it’s headed downward. I bet the market in general will greatly influence that aspect.
I don’t really care about the direction NFLX meanders in … I’d rather create income selling downside risk against what others are fretting now. The trick is to sell below support that will hold through expiration.
NFLX Stock Options
The Trade: Sell the Oct $125 put for $1 per contract. Here, there’s a 85% theoretical odds of winning maximum gains. But if Netflix shares fall below $124, I could accrue losses.
I can moderate the risk of selling naked puts, but using spreads instead. There the amount at risk is equal to the width of the spread less what I collect to open the trade.
The Alternate Trade: Sell the $130/$125 credit put spread, which has about the same odds of success. Yet, it could still yield 8%.
In either case, I have a healthy buffer from current price, so I could still profit even if NFLX falls another 20%. Comparatively, I’d have to risk $166 buying Netflix stock outright and, without any room for error, expect an 8% rally to match this trade.
No matter the trade, the stock markets are risky. Never risk more than you can afford to lose.
Learn how to generate income from options here. 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.
