Netflix, Inc. (NASDAQ:NFLX) is up 1,400% in five years. Needless to say, the online streaming service is a hit. It had a few flubs along the way, but the transition from CD deliveries by mail to online delivery was well received en mass. As a result, NFLX currently has a huge early entrant advantage.
Naturally, now that the streaming model is a proven success, potential competition is fierce. The list of new comers should terrify NFLX management, but they are hiding it well. This is a critical point and it think could come back to haunt them. The company will suffer at the hands of gorillas like Apple Inc. (NASDAQ:AAPL), Walt Disney Co (NYSE:DIS), Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB).
NFLX gained popularity in the U.S. very quickly. NFLX stock bulls extrapolate that the global market penetration has huge upside potential for the company. Consequently, Wall Street loves the stock so much so that it trades with a price-to-earnings ratio of 200.
NFLX stock is not cheap.
How to Trade NFLX Stock
While I don’t doubt its popularity, I am still a skeptic with regards to the financial model for Netflix. I worry that it could be too costly to maintain its original content output and compete with lower-margin competitors. But for now and in spite of that, I am sharing a bullish set up because as much as I dislike the future valuation, I love the way the stock trades.
In the absence of tangible value, my bet is against proven short-term support. I will sell downside risk into 2018. If it holds, I would create income from nothing. It’s important to note that I don’t even need a rally to win.
But if one comes, then my profits would materialize faster.
If I am wrong, then I would have the opportunity to buy NFLX shares at a big discount from current levels. So even the worst case scenario on this trade is not so bad. As long as the current macroeconomic thesis persists, I am confident that I can manage out of my shares for a profit.
Experts expect big things from Netflix stock. It is now trading 12% below the average price target on Wall Street, so they are expecting rallies. Those could come, but it would need help from the equity markets in general.
The thesis is simple. Dips are scarce and we just got one. So I want to create income from NFLX stock, but leave plenty of room for error so I bet on recent support to hold into 2018.
The Trade: Sell the NFLX Jan 2018 $155 put for $1.50. Here I have an 85% theoretical chance of success. Otherwise, I own the shares and I accrue losses below $153.50.
Selling naked puts carries big risk, especially in a stock as frothy and as expensive as NFLX. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the NFLX $160/$155 Credit put spread, where I have about the same odds of success but with much less risk. If the spread wins, it would deliver 10% in yield. Compare this with risking $186-per-share and hoping for a rally to profit without any room for error.
Ultimately, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free 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.
