While markets are busy setting new highs, it’s becoming harder to find stocks to buy with conviction. At this altitude, investors must commit their assets for the very long term. From here, the easy work is done and the upside in equities is smaller than the downside risk, especially for the medium-term. This is more true for FANG stocks as they are the high-profile tickers that all investors chase of late.
Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX) are three of the four within the famous acronym that are most controversial. They have armies of haters and super fans that make them more momentous than most stocks on Wall Street. Only Facebook set all-time highs last week, so arguably there still is upside potential for at least Netflix and Amazon. Tomorrow’s open will be a wild one since the FANG gang will trade in sympathy to the Netflix earnings reaction.
However the point of today’s note is to trade them regardless of where they are in the rally cycle. To do that we must delve into the world of options where investors can deploy trades that don’t require rallies to profit.
Using options investors can trade Facebook, Netflix, and Amazon indirectly by trading their stock prices for a specific period of time. I consider this the equivalent of taking a profitable bite out of FANG stocks without committing to a full meal.
Netflix subscribers are global. That’s the upside potential that Wall Street sees in the stock. That is why it rallied from $100 per share in 2016 to its high of $420 in June of 2018. But since then it has failed to beat that mark. With an earnings report tonight, committing new money to NFLX stock has an immediate binary event that has little to do with the fundamentals.
The short term reaction to earnings is mostly fueled by emotions. These are usually based more so on expectations rather than actual results. Investors have so far assigned a high valuation to Netflix because of the potential they see for its global growth. If management fails to deliver the headlines on that front then it is likely that the stock will temporarily fall.
Netflix spends almost $20 billion on exclusive content. That is the bait it uses to lure and keep new subscribers. This is not an issue while money is cheap, but with so much competition on its heels, NFLX cannot afford any missteps else it could suffer tremendous losses. Disney (NYSE:DIS), Comcast (NASDAQ:CMCSA), and Apple (NASDAQ:AAPL) are just three of its recent competitors and they, too, have deep pockets. To ignore them would be reckless, but so far, investors still believe that CEO Reed Hastings is up to the task.
Since Netflix has a huge lead from being the first mover in streaming it is not likely that the stock will collapse from here. Even if the upside potential is capped, the worst case scenario is not likely to unfold in a flash. There are no imminent signs of a crash in the stock.
Moreover, there is the possibility that management delivers great news and that the stock will soar, finally catching up to the rest of the indices and making its new highs above $420 per share. But since there is a big element of gambling around the earnings report, instead of committing new upside hopium risk by buying the stock, investors can use options for that.
By selling the June $240 put, investors can collect more than $3 per contract. This leaves a 30% buffer between current levels and the risk of losing money. If Netflix stays above said put then the trade delivers its maximums gains. Else there is no loss unless price falls below $237 per share. Compare this with risking $340 now and going into earnings with absolutely no room for error.
Last year, investors latched on to the idea that Amazon was in a spending year, so they avoided the stock. Consequently it lagged the fang gang as it lacked momentum. So while it is doing better than Netflix, Amazon is up half as much as the S&P 500 and 35% behind Facebook in the last 12 months.
But more often than not, when Amazon spends money it reaps the rewards in a big way. Getting their AWS cash cow came from such spending periods so logic suggests they will find another one soon. Critics hate the fact that AWS is losing market share to Microsoft (NASDAQ:MSFT) and others but that is an inevitable fact. Amazon is the king of the hill in cloud, so it’s normal to lose share to those who are still playing catch up.
Under the leadership of Jeff Bezos, Amazon has a proven management team so they deserve the benefit of the doubt. This is a stock to hold for the long term. But since the market is at all-time highs then some caution is warranted, especially if the investor time frame is narrower.
Since Amazon is a momentum stock then it would be risky to own it just before a pull back. The good news is that it spent a lot of time consolidating around $1,700 per share, so that provides support in case it dips. Nevertheless, this would account for a $160 loss for those who buy it here.
This is where the options markets offer alternative ways of getting long AMZN stock while leaving plenty of room for error. Instead of risking $1,864 per share, the investor can sell the March $1,600 put and collect $7 per contract. If Amazon stays above it then the whole amount is pure profit with no money out of pocket. There will be losses below $1,593 per share. Compare that to owning the shares all the way down from $1,864. In this case the investor would have a 15% buffer before suffering any losses.
Unlike the other two stocks, Facebook has already set new all-time highs last week. In 2018 Facebook stock corrected more than 40% before it found footing near $123 per share. Back then it was a combination of market-wide fears and worries over FB-specific challenges that spurred from the privacy concerns. There were also matters of antitrust that still linger but they are not making headlines of late. Bulls have been completely in charge of the Facebook price action.
Consequently, the stock broke out from $204 per share to close at an all-time high of $222. The easy work has been done and it is now vulnerable to corrections. This is not a bearish statement, but stocks never rally to the moon without taking breaks. Sustainable rallies need time to consolidate and build strong bases, else investors take the escalators up and the elevators down.
The idea is to wait for better entry points before committing new long term capital to Facebook stock. Or alternatively use the options markets where traders can bet on the range of prices. This eliminates the need to find the perfect entry points. In this case, investors can sell the June Facebook $175 put and collect $2. This would leave a 21% buffer from current price before losing money.
This way, if the stock stays above the put sold the investor achieves maximum gains. Let the bulls and bears fight it out between now and expiration. This trade setup requires neither side to win as long as Facebook holds its prior proven supports.