Netflix, Inc. (NASDAQ:NFLX) reported earnings last night and traders so far like what they saw. But if the move continues to be somewhat muted there will downside risk for the next few days. The options market had been expecting a +/- $16 move and they only got half.
Nevertheless today I want to profit long Netflix stock but before you label me another perma-bull, listen to my perspective. It is not that great for NFLX long term.
Regardless of value, the NFLX bullish trade remains easier than the short one. The problem for the bears is that the bullish thesis is long term in nature. Wall Street allows for the extremely high valuations in anticipation of global growth.
Basically, they are extrapolating its growth outside the U.S. to mirror that of its domestic success. So for now, it’s hard to refute this proposition without the evidence of time. It will take months if not years to prove the thesis wrong.
Meanwhile, critics could nitpick in the NFLX fundamentals. Management spends too much money on content, but without it, there’s no growth. Under normal circumstances, this alone doesn’t worry me that much. However, in this case, there are massive competitors playing catch up so the spending is only likely to get worse.
Most of NFLX upcoming competitors have much deeper pockets. Most dangerous of all is Amazon.com, Inc. (NASDAQ:AMZN). This is a company that causes more carnage in competitors’ stocks than any other in history.
The list also includes Alphabet Inc (NASDAQ:GOOGL), Apple Inc. (NASDAQ:AAPL), Walt Disney Co (NYSE:DIS) and Facebook Inc (NASDAQ:FB). Hulu is coming on strong with heavy advertising. Traditional media is also fully committed and full steam ahead to the online streaming model.
Click to Enlarge I foresee that NFLX operating model will need to change eventually. But for today, I will put my long-term views aside because I do like the way the stock price trades in the short term.
Netflix fans are dedicated to its stock so they are likely to keep it supported for the next few months. Furthermore, NFLX CEO is also dedicated to propping up the stock price. He will use words to provide support if and when it’s needed.
From a valuation perspective and with a 250 price-earnings ratio NFLX is not cheap. It sells at 32 times book value and its long-term debt is growing fast. Not to mention off-balance sheet commitments that some bears speculate exists.
Expectations are important when it comes to price action. Most experts on Wall Street who cover stock have a “hold” rating on it. NFLX stock is now trading above the $202 per share average price target. It has much less room above than below based within the overall range of estimates. So at this point, the analysts have to either adjust their prices higher or reconsider their long positions.
Technically, the stock is up almost 100% in 12 months. I am not one to chase rallies this late especially when I don’t believe in the long-term viability of the stock under its current structure. But I do want to participate in the exuberance around Netflix. So I will use options where I can be bullish the stock but the broom for error.
A fast-rising stock usually creates rising wedges. These could create technical pitfalls, especially that markets are at all-time highs. I do see levels where NFLX should find support in the near term, though. And therein lies my opportunity.
Consider this a bet that support will continue to exist through the year.
The Bet: Sell NFLX Dec $165 naked put. This is a bullish trade for which I collect $1.75 per contract to open. I have 90% theoretical chance that price will stay above my strike. Otherwise, I own the shares and can suffer losses below $163.25.
Selling naked puts carries big risk especially in a stock as expensive as NFLX. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell the NFLX Dec $170/$165 credit put spread which can deliver 15% yield. Both trades have the same odds of winning.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing 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 as @racernic on twitter and stocktwits.