Why You Should Stop Binging On Netflix, Inc. Stock As It Nears $400

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NFLX stock - Why You Should Stop Binging On Netflix, Inc. Stock As It Nears $400

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Shares of Netflix, Inc. (NASDAQ:NFLX) have been on an incredible run so far in 2018. NFLX stock is now up over 83% year-to-date, making it the second best performing stock in the S&P 500 and far outpacing the roughly 2% gain for that index. Undoubtedly Netflix has become an iconic brand and it is a fixture of the new age of media. However, the recent performance in NFLX stock smacks of “too far, too fast.” Look for the red-hot rally to stall over the coming weeks.

The latest leg of the rally was fueled by a price target increase to $490 from Goldman Sachs. In the note from last Wednesday, analyst Heath Terry expects Netflix to add 32.5 million new subscribers versus consensus of 26 million, while spending $2 billion on content. He also looks for Netflix to finally become significantly cash flow positive in 2022, which means it has been burning cash big time so far.

While the new subscriber growth rate is certainly impressive, the law of large numbers simply means it can’t continue, especially given that the company already has 125 million current subscribers. NFLX has always been valued on the future, so normal valuation metrics such as price-to-earnings ratio and price-to-cash-flow have been deeply discounted. But at some point valuation does matter. Paying over 50 times 2022 earnings for a $170 billion market cap company that may finally become cash flow positive seems rather extreme to me.

From a technical perspective, NFLX stock is getting decidedly overbought. Its nine-day RSI just breached the 80 level for only the fourth time over the past year. The previous three instances proved to be significant short-term tops. Netflix is also trading at a large premium to the 50-day-moving-average of $333.42. In the past, when NFLX stock was at such lofty comparative levels, it inevitably lead to a pullback in the stock.


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Most importantly, NFLX stock experienced a reversal on Friday. Its shares attempted to break past the $400 level, trading up to $398.86 before pivoting and actually closing lower on the day. This type of price action is many times emblematic of a top in the stock, especially following such a massive rally. The failure to hold on to gains indicates the buyers may finally be tired of NFLX.

Implied volatility (IV) in NFLX is at recent highs at the 52nd percentile. IV is also far above historic volatility, meaning option prices are comparatively rich. This favors option selling strategies when constructing trades.

So to position for a period of consolidation in NFLX, a bearish call credit spread makes sense.

NFLX Stock Trade Idea

Buy the NFLX July $445 calls and sell the NFLX July $440 calls for a 80 cents net credit.

Maximum gain on the trade is $80-per-spread with maximum risk of $420-per-spread. Return on risk is 19.04%. The short $440 strike provides a 12% upside cushion to the $391.98 closing price of NFLX stock.

Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility/.

Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, four years as Lead Options Strategist at ThinkorSwim and three years as a Market Maker for First Options in Chicago. Tim makes weekly appearances on Bloomberg TV  “Options Insight”, Business First AM “Trader Talk”, TD Ameritade Network “Morning Trade Live” and CBOE-TV “Vol 411” to discuss everything from volatility and option related.


Article printed from InvestorPlace Media, https://investorplace.com/2018/06/why-you-should-stop-binging-on-netflix-inc-stock-as-it-nears-400/.

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