Shares of Netflix, Inc. (NASDAQ:NFLX) have been on an absolute monster rally so far this year, rising 69% year to date. This makes Netflix stock the best performer in the S&P 500 by a wide margin. While subscriber growth certainly was impressive in the latest earnings report, cash burn remains an issue. Don’t get me wrong — I am a huge Netflix fan. I just think NFLX stock has come too far, too fast and is due for a period of consolidation.
Any discussion of valuation surrounding big-time momentum stocks like Netflix borders on absurd. The current price-to-earnings ratio of over 200 is obviously in nosebleed territory. More importantly, it is now at the highest level over the past year on a comparative basis. Even the true believers in Netflix stock should be getting a little cautious given that fact.
The latest earnings report came in right in line with analyst expectations of 41 cents in earnings on $3.28 billion in revenue. The main driver of the rip roaring post earnings rally was subscriber growth, which came in red hot at 8.33 million new subscribers versus an anticipated 6.39 million adds.
Click to EnlargeI think that future growth rates necessarily have to temper simply due to the law of large numbers. Plus there is always that pesky cash burn rate ($3-$4 billion expected in 2018) for content acquisition that continues to be mostly overlooked.
Momentum stocks are definitely better analyzed from a technical perspective. Netflix stock is getting way overbought on a nine-day RSI basis with readings above 80. The previous two times NFLX reached such extremes proved to be a short term top in the stock.
Implied volatility (IV) in Netflix stock options is at an extreme. Reading are at the 99th percentile, making options prices very rich on a comparative basis, favoring option selling strategies. So to position for a stall out in the NFLX rally a bearish call spread in NFLX options is the preferred trade structure.
NFLX Stock Trade Idea
Buy NFLX Apr $375 calls and sell Apr $370 calls for a 70-cent net credit
Maximum gain on the trade is $70 per spread with maximum risk of $430 per spread. Return on risk is 16.27%. the short $370 strike provides a 13.76% upside cushion to the $325.22 closing price of Netflix 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 [email protected]