Shares of Netflix, Inc. (NASDAQ:NFLX) have been on an absolute monster run, rising nearly 50% since the beginning of the year. NFLX recently breached the $100 billion market cap for the first time ever and is fast approaching rival (and former partner) Walt Disney Co (NYSE:DIS) in that metric. While nearly everyone loves Netflix (myself included), I am definitely not loving the near vertical-and unsustainable-rally in NFLX stock. Look for the Netflix stock to cool down over the coming weeks.
The impetus behind the recent incredible rally was the latest earnings report from Jan. 22. While earnings and revenues were basically in line with analysts consensus of 41 cents earnings-per-share and 3.28 billion in revenue, it was the subscriber growth that sent shares into the stratosphere. There were 8.33 million new net additions versus expectations of 6.39 million, mostly overseas.
While it is undoubtedly a more than impressive number, it also is very likely as good as it gets considering the magnitude of the subscriber beat. The law of large numbers certainly begins to apply to future subscriber growth. Also lest we not forget that Netflix continues to burn cash at a rather staggering rate. Then there is always that rather pesky current P/E ratio that still resides north of 200. The price to sales ratio of nearly 11 is no bargain either.
How to Trade NFLX Stock
From a technical perspective, Netflix is trading at extremes never before seen. The 9 day RSI is at an unbelievable reading of 95, while the MACD is over 6. Its bollinger bands have blown out to epic proportions and Netflix still closed 6 points above the upper band. A quick cursory look at the chart is all that is really needed to see the parabolic move higher.
InvestorPlace Chief Technical Analyst Serge Berger weighed in yesterday with a well reasoned piece highlighting the concerns over the recent price action in Netflix. He recommended aggressive traders wait for an exhaustion in Netflix stock before entering into a short position via puts, put spreads or an outright short stock trade.
Prudent advice indeed.
There are, however, defined risk trades that can be implemented right now to take advantage of the historically overbought conditions in Netflix stock. This type of trade is predicated more of a tempering in the Netflix rally rather than a major pullback.
Implied volatility (IV) currently stands in the 82nd percentile (even post earnings!), meaning NFLX option prices are still very expensive. To me, this favors option selling strategies, such as bearish call credit spreads, when structuring trades.
NFLX Stock Trade Idea
Buy the NFLX Feb $315 calls and sell the NFLX Feb $310 calls for a 70 cents net credit.
Maximum return is $70-per-spread with a maximum risk of $430-per-spread. Return on risk is 16.27%. The short $310 strike price provides an 8.9% upside cushion to the $284.59 closing price of NFLX stock.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com
