Netflix put in some bearish price action the last few days. And this is after already plummeting 75% off its highs. While Netflix stock might not go down much further, you can still benefit from time passing with a bear call spread.
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy profits in a number of ways. If Netflix stock trades lower, sideways or even if it trades slightly higher, this option trade can profit. The price just needs to stay below the short call at expiration.
Bear Call Spread On Netflix Stock
On Netflix stock, an August expiry bear call spread could be set up using the 210 strike as the short call and the 215 strike as the long call.
Yesterday, that spread was trading for around $0.90 and it was at a similar level today.
If executed at that price, the maximum profit on the trade would be $90 per contract with a maximum risk of $410. Calculate that by taking the difference between the spreads and subtracting the premium received, then multiplying by 100.
How does Netflix stock achieve maximum profit for this spread? If NFLX stock closes below 210 on Aug. 19, the entire spread expires worthless. As the seller, that means you keep the $90 option premium received. That doesn't seem unreasonable with Netflix trading below 200 for the majority of the last three months.
The maximum loss occurs if NFLX closes above 215 on Aug. 19, which would see the premium seller lose $410 on the trade. In that case, you start losing profit on your short call as the stock moves above 210. You have your premium to give you some cushion beyond that.
Finally, the long call at 215 limits your losses if Netflix stock has a much bigger move to the upside. The gains from the long call at 215 offset the losses of the short call at 210.
That makes this trade a risk-defined strategy. While some option trades have the risk of unlimited losses, you always know the worst-case scenario in advance for a bear call spread.
Setting A Stop Loss
But you don't have to let the loss get to its maximum before taking action. You can either use your option value or the stock itself to set a stop loss.
If the spread doubles in value from 90 cents to $1.80, you might want to cover the position to keep your loss small. Or if Netflix stock starts trading above 200, you might reconsider your thesis on the stock.
According to IBD Stock Checkup, Netflix stock is ranked No. 6 in its industry group and has a Composite Rating of 43, an EPS Rating of 89 and a dismal Relative Strength Rating of 5.
Earnings are due on July 19 after the market close, so this trade does have earnings risk.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
