Netflix continues to go from strength to strength since getting back above its 50-day moving average. Therefore, the idea we are looking at today is a bull put spread options trade in Netflix stock.
As a reminder, a bull put spread is a defined-risk strategy, so you always know the worst-case scenario in advance.
This type of trade will profit if Netflix stock trades sideways or higher, and even sometimes if it trades slightly lower.
On Oct. 19, shares soared 16% in the heaviest volume for a single session since January after the firm surprised Wall Street with solid third-quarter growth in paying subscribers.
The Los Gatos, Calif.-based firm also announced an acceleration in quarterly growth. Earnings per share lifted 20% to $3.73 a share, improving upon a 3% year-over-year increase in Q2. Q3 revenue expanded 8% to $8.54 billion.
Netflix Stock Today: A Bull Put Spread Setup
With NFLX trading around 432, if we use the Dec. 15 expiration, we can sell a 400 put and simultaneously buy a 395 put for around $0.90 per option contract. One put contract gives the holder the right, but not the obligation, to sell 100 shares of a stock at a given price (the strike) up until a certain date (the contract expiration).
Selling this spread would generate roughly $90 in premium, based on recent trading. The trade also generates a maximum risk of $410 per set of contracts.
If the spread expires worthless, that would result in a 21.95% return in just over one month — provided NFLX stock trades above 400 at expiration.
How would the maximum loss would occur? If NFLX stock closes below 395 on Dec. 15. In such a case, the premium seller loses $410 on the trade.
The break-even point for the trade: 399.10, calculated by taking 400 less 0.90 in option premium received per contract.
Where To Limit Risk
I would set a stop loss if NFLX drops below 405. Otherwise, another good rule of thumb is to limit the loss to the amount of premium received, which in this case would be $90.
Sticking to this stop loss level will help avoid large losses if the trade goes south.
According to IBD Stock Checkup, NFLX stock ranks No. 2 in its industry group. It has a Composite Rating of 96, an EPS Rating of 94 and a Relative Strength Rating of 94.
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
