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A large tranche of Netflix Inc (NFLX) call options that are in-the-money (ITM) shows that an institutional investor has taken a large position using the call options with just 51 days to expiration. That indicates that the investor has a bullish outlook on the stock, and probably has faith that the company will show membership growth and good free cash flow growth in Q2.
This trade can be seen in Barchart's Unusual Stock Options Activity Report today. The tranche that was bought was 3.7% in-the-money (ITM), which means that the call option strike price of $415.00 per share is actually below today's stock price of $431.00. That usually implies that the initiating investor in the call option trade is long the calls - i.e., they bought the calls.
This trade is over 19x times the existing number of contracts in $415.00 strike price calls expiring Aug. 18. Since this call option strike price is below the spot price it is likely that the investor has gone the calls.
This makes sense if they expect the stock to rise significantly. In effect, they gain a cheaper way of buying NFLX stock and effectively leverage their available investment funds.
For example, in this case, the premium for the NFLX calls was $37.00 for the expiration period 51 days from now on August 18, 2023. That means that the investor expects NFLX stock will rise over $452 per share (i.e., $415 strike price + $37.00 premium paid for the calls).
The call options in effect are at a 4.9% premium over today's price (i.e., $452/$431-1=4.87%). So the investor is effectively bullish that NFLX will rise well over 5% in the next 52 days to Aug 18.
Why The Trade in NFLX Call Options Makes Sense
We discussed why investors are now bullish on NFLX stock in our recent June 11 Barchart article, “Netflix Stock Is Soaring, As Traders Expect Higher Sub Growth.” For example, we wrote that investors suspect subscriber growth will come in higher than expected, given the launch of its new shared password project.
We also pointed out that the stock's forward price/earnings (P/E) multiple is significantly lower than its historical averages.
For example, today NFLX trades on a 2023 multiple of 37x and a 2024 multiple of 28.6x. That is much lower than its 5-year multiple averages of 58.2x according to Morningstar and 65x according to Seeking Alpha.
More importantly, investors now expect subscriber growth could spur further increases in its positive free cash flow (FCF). Last quarter its subscribers grew 4.9% YoY to 232.5 million subscribers.
Moreover, Netflix now says it expects to generate $3.5 billion in free cash flow (FCF) for the year, up from $3.0 billion earlier. This implies Netflix could reach $5 billion in FCF by 2024.
That could lead to a significantly higher market capitalization. For example, using a 45x multiple of FCF, NFLX stock could reach $225 billion. That is over 21% higher than today's 185 billion market capitalization for Netflix.
In other words, NFLX stock could still rise further from here, especially if it stays on track to produce significant free cash flow. The results for Q2 will clearly show whether this is the case.
That is why the long-call investor believes this is the best way to play going long NFLX stock.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
