Netflix fell sharply following the report of its first-quarter results. So, now may be an opportune time to look at a long butterfly spread in Netflix stock by using put options.
With Netflix earnings now in the rearview mirror, traders have a chance to see what the next few months of motion might look like. The company offered sales guidance lower than Wall Street expectations and disclosed quarterly updates on net subscriber additions will end. Thus, the fade looks likely for this stock over the coming months.
With the broad markets in search of value areas below, we can err on the side of caution with a highflier like Netflix stock to slip into valuations that are more palatable.
Group leadership for Netflix stock shows that it remains the juggernaut of streaming software. However, with Netflix surging more than 85% in six months, one may expect a pullback under current market conditions.
According to IBD Stock Checkup, NFLX leads the leisure-movies industry group with a 99 Composite Rating. However, this rating is best used a stock selection research tool, not for making trade decisions.
Netflix Stock Today: The Options Trade
The long put butterfly spread is a neutral to bearish position. It estimates that prices will move to a lower range, which allows us to capture price movement at a reduced cost.
We could set up the long butterfly put spread in Netflix stock as follows:
- Buy to open 1 NFLX June 21-expiring put option with a 580 strike price
- Sell to open 2 NFLX June 21 540 puts
- Buy to open 1 NFLX June 21 500 put
Total debit ahead of Friday's action totaled $6.70 per set of contracts. This gives a break-even cost for Netflix stock at 573.30 — the cost of the position minus the highest strike price. However, in more recent trading, the fade in Netflix stock has made the butterfly spread trade much more expensive at $8 per set of contracts, or $800. But the profit markers also have higher probability levels of profit.
The ideal strategy result gives us three choices to exit the trade. One, sell the spread once it carries an acceptable profit — around 50% for me. Two, sell the spread once it hits your loss threshold as determined by personal risk. And three, sell the spread once the price of Netflix stock hits the middle strike, or 540, for the highest percentage return.
Stock hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
Understanding The Long Put Butterfly Spread
The goal of taking the long put butterfly spread? Benefit from selling options further out of the money to bring down the cost of the overall position. The counterpoint here? The short spread of this trade can erode the profit from the long spread if the price action is very deep.
Options sellers are positioned to win in two ways. One, Netflix stock does nothing. Or two, the stock moves within the ranges relative to the strategy, so we use this concept to minimize the risk of market exposure.
Let's now identify key chart levels. The monthly resistance zone sits well off its current highs of 640. Buying support for Netflix stock sits near 540. The last level gives us the middle strike of our butterfly, or where we expect price to hold for a time.
Netflix Stock: Scenarios To Consider
- Netflix stock grinds higher or lower into our risk thresholds. We exit the trade.
- Shares stay in a range and we see the erosion of value in our butterfly.
- The stock grinds lower into our profit thresholds and we exit the trade.
- Netflix stock moves lower into the middle strike. We leave for maximum gains at the time the stock tests this price level. If NFLX moves to the middle strike of 540 with two weeks before expiration, then marks the highest probability sweet spot for this trade.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully. Be patient and allow price action to move around a range of your stops.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on Twitter and Stocktwits at @AnneMarieTrades
