Netflix heads into the new year up more than 4,000% this decade, making it the best performer in the S&P 500 throughout the last 10 years.
However, the streaming environment is much different from what it was when the decade began, and there are signs that the next decade won’t be quite as kind to Netflix. More competition has hurt the stock in 2019, to the point that it is slightly underperforming the broader market, but if you’re of the opinion that Netflix can adapt and survive the next 10 years, there is a way to play it without risking it all.
“We’re going to talk about executing a call calendar spread in Netflix. And why is that? Well, as you would expect with any stock that’s rallied 4,000%, it is pretty pricey.” NationsShares founder Scott Nations said Friday on “Options Action.”
“The [price to earnings ratio] right now for this is in triple digits —105. So, we can’t just run out and buy the stock even though we love the company,” said Nations.
The thesis is fairly simple, as Nations sees it. If you believe that Netflix is heading higher in the new year, but you’re not willing to buy stock outright because of inherent risk exposure, a call calendar is a capital-efficient way to get access to potentially uncapped upside while defining your downside risk.
“Not only is [Netflix] up a bunch, and it would be really expensive if we were to buy it and see it collapse, but there are actually some shorter-term problems with the stock,” said Nations. “But with a name that’s been up 4,000% in the last 10 years, we want unlimited profit potential.”
“We don’t want to be trading this name for a small profit, given what we’ve seen what it’s capable of.”
As Nations pointed out, Netflix has been unable to regain its prior 2019 high, even as the broader market has surged out to new highs in the back half of this year. The stock has come close to retaking the level it gapped down to in late July but failed to push above a key resistance level of around $340.
However, that doesn’t mean it never will, and Nations thinks there is upside ahead for those willing to play that side of the stock.
“Earlier [Friday], you could buy the February-March 350-strike call calendar,” said Nations. “We’re buying the March 350-strike call, paying $13.50, and to reduce the risk and reduce the cost, we’re going to sell that same option, that is the 350-strike call in the February expiration, and we could sell that for $10.80.”
As Nations points out, this trade only costs $2.70 in premium. That $2.70 is your maximum risk per contract, and puts the trade’s breakeven level at an underlying stock price of $352.70 by March expiration.
“What do we want Netflix to do? This works best when that February option expires worthless,” said Nations. “We want Netflix to be below $350 at that February expiration. That call will then expire worthless, and that leaves us just net long this March 350-call.”
From there, this trade grants access to potentially unlimited upside. The higher Netflix surges into that March expiration, the more profits the trader sees.
Netflix was trading about 1% lower on Monday.
