Shares of Netflix (NASDAQ:NFLX) have certainly been under pressure lately. Netflix stock is now down 30% since early July when NFLX made a high around $380. It also just turned negative on the year. While undoubtedly some of the selling is warranted given the increased competition and slowing growth, the carnage is now getting overdone. Time to be a buyer of Netflix stock on any further weakness.
Barclays’ latest attempt to value Netflix stock under a new valuation framework smacks of the absurd. Analyst Kannan Venkateshwar said NFLX would need roughly a billion subscribers to justify the current expensive valuation in a note yesterday. Yet Barclays still rates Netflix as an overweight with a $375 price target.
On Friday, Piper Jaffray came out in defense of the stock with a reiteration of an overweight and a $440 price target. Senior research analyst Michael Olson recommended buying the dip. While my price target may not be as lofty (a return to the 20-day moving average at $290), I tend to agree that NFLX stock is approaching a meaningful buy area.
Undoubtedly the streaming space is getting even more crowded and competitive. Heavyweights Apple (NASDAQ:AAPL) and Disney (NYSE:DIS) are the latest to launch their services. Netflix, however, has the first mover advantage and will continue to grow, albeit not at the previous torrid pace. Piper Jaffray echoes that sentiment, stating “There should be a positive impact from an improving slate and we are, therefore, optimistic about the company’s opportunity to grow subscriber additions y/y on a FY basis.”
Netflix stock is getting extremely oversold on a technical basis. 5-day RSI is below 15 and at levels that have signaled a low in the past. Bollinger Percent B is at the lowest reading of the past several years and decidedly negative. Money flow is also fast approaching overly pessimistic levels that corresponded with reversals previously. NFLX is trading at a huge discount to the 20-day moving average which has been a precursor to pop in the past. There is major horizontal support at the $250 level.
Netflix option prices are getting rather richly priced, especially on a relative basis. The current implied volatility (IV) percentile is at 49% and well above the current historical volatility percentile of just 17%. This favors option selling strategies when constructing trades.
To position to be a buyer on further weakness in Netflix stock, an out of the money bull put spread makes probabilistic sense. It also captures some rich option premium as you wait for the weakness.
How to Trade NFLX Stock
Sell the NFLX October $250/$245 put spread for $1.60 net credit. Maximum gain on the trade is $160 per spread with maximum risk of $340 per spread. Return on risk is 47%. The short $250 strike provides a 6% downside cushion to the $265.92 closing price of Netflix stock. It also corresponds with the major support level at $250.
Look for Netflix stock to challenge the 20-day moving average at $290 as the initial upside price target. A meaningful break of the $250 support would be a viable stop out level.
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.
