Netflix has dropped in recent weeks and is holding just above the 50-day moving average. So, today, I want to look at a strategy in Netflix stock with little risk on the upside and a healthy profit zone on the downside.
The strategy is called a broken wing butterfly. And we'll use puts because the strikes will all start below the price of Netflix stock price. This helps to reduce assignment risk.
With a regular butterfly option trade, the wings are placed an equal distance away from the short strike. But with a broken wing butterfly, we leave a larger gap on a particular side.
This results in less risk on one side and more risk on the opposite side.
Netflix stock currently holds a respectable Composite Rating of 94 on a scale of 1 to 99, according to IBD Stock Checkup.
Netflix Stock: Setting Up A Broken Wing Butterfly
Let's take a look at how a broken wing butterfly trade might be set up on NFLX:
- Buy 1 Sept. 15, expiring put option, 360 strike price, at 1.75
- Sell 2 Sept. 15, 400 put options at 7.00
- Buy 1 Sept. 15, 420 put at 12.95
Notice that the upper strike put lies 20 points away from the middle put option for Netflix stock. The lower-priced put, however, stands 40 points away.
This broken wing butterfly trade can be placed for a small debit, which means there is very little risk on the upside.
The worst that can happen is all the puts expire worthless, leaving the trader with a $70 loss. However, on the downside, the maximum loss can be calculated by taking the width between the middle and upper strikes (20) multiplied by 100, plus the premium paid. That gives us 20 x 100 + 70 = $2,070.
Calculate the maximum gain as 20 x 100 - 70 = $1,930.
The ideal scenario for the trade? Netflix stock stays flat initially and then slowly drifts lower to close around 400 at expiration. The total profit zone is between 380 and 420.
Managing Risk
The trade starts with delta of 1, so has a slight bullish bias to start, but that will flip to negative delta closer to expiry if the stock is still above 400.
In terms of risk management, I would set a stop loss of 20% of the capital at risk, or if NFLX broke below 380.
This diagonal put spread on NFLX from a few weeks ago can be closed for a nice profit.
It's important to 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.
