This Stock’s Drop is a Gift: Trade it with Confidence

Recently, the stock market has been on a roller coaster ride from the slew of global tariff headlines most notable against China. So far, Netflix (NASDAQ:NFLX) has been somewhat sheltered from it since China is not the heart of the growth thesis.

Consequently, NFLX stock just recently set a record high and had been up 100% year-to-date. But that all changed [Monday] night when Reed Hastings & Co. reported earnings after hours and investors hated it. NFLX stock fell 14% on the headline.

The experts’ have voiced plenty of wordy opinions, but to me, the facts are simple: Netflix is growing at a neck-breaking rate and NFLX stock carries a very frothy valuation.

Netflix’s earnings report doesn’t change either of those facts and therein lies the opportunity.

Let me start by remind you that I am not a Netflix stock perma-bull as I’ve been on record noting the dangers its bottom line will face down the road from the margin pressures that will come in a few years from the competition.

The list of companies that are pursuing NFLX is laced with mega caps with deep pockets.

Alphabet (NASDAQ:GOOGL), DIS, (NASDAQ:AMZN) and Facebook (NASDAQ:FB) to name a few so the threat is very real..

This was an emphatically bad earnings headline as management missed on the most important metric to Wall Street: New subscriber additions were a million short of expectations. Worse even, is that they lowered the forward guidance.

Although Mr. Hastings did mention the competition in his letter to investors, he said it wasn’t the reason for the miss. Rather he blamed the way they estimate the goals. This sounds petty to me but I do understand the point. There is plenty of runway to go in their global expansion plans.

In the face of this bad new subs miss investors missed the fact that their actual sales and earnings are exploding higher but for now the headline is not what investors expected and they are expressing themselves. It’s a simple fact of lofty short-term expectations because they NFLX conditioned Wall Street to expect stellar results like they have been delivering especially on the new subscriber front.

The bottom line is that the story hasn’t change. The only difference between today and yesterday is that we now have had a reality check going into the next report. The company is still on rails and expanding at an incredible rate.

The NFLX stock fans will remain gun-ho and will dig in their heels. On the other hand, the shorts will get a mark in the win column today. I believe that both extreme arguments are wrong and somewhere in the middle lies the truth.

Luckily today’s trade needs neither opinions to give me profits. My worst case scenario is that I own NFLX shares at another 20% lower than here if the stock falls through my strike in 2018.

The Bet: Sell NFLX Jan 2019 $250 naked put. This is a bullish trade where I collect $5 to open. Here I have a 80% theoretical chance of success. But if price falls below my strike then I accrue losses below $245.

Selling naked puts carries big risk especially for a stock as frothy as NFLX. For those who want to mitigate it, they can sell a spread instead.

The Alternate Bet: Sell the NFLX Jan 2019 $250/$245 bull put spread. Here my risk is smaller yet the spread would yield 15% on risk. Compare this with risking 352 to buy the shares and leave no room for error.

— Nicolas Chahine

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Source: Investor Place