Updating My Outlook On Netflix After The Earnings Beat

Apr.23.13 | About: Netflix, Inc. (NFLX)

Since my previous positive mention of Netflix (NASDAQ:NFLX) on May 14, 2012, as shown in the chart below, shares are up more than 180%.

NFLX ChartNFLX data by YCharts

Positive Earnings

The main reason why NFLX shares have moved higher has been better than expected earnings:

  • 2 million new U.S. streaming customers
  • Adjusted earnings of 31 cents per share compared to forecast of 19 cents per share
  • 1 million new streaming customers in markets outside the U.S. including Canada, Europe, and Latin America
  • $1 billion revenue

Clearly, NFLX is firing on all cylinders right now. This earnings report marks the second consecutive earnings blowout by the company; in late January, NFLX also reported very strong numbers for the fourth quarter of last year.

Insider Sale

In my previous piece, one of the reasons why I was bullish on NFLX despite the weak price action was a large insider purchase by board member Jay Hoag. In total, at the time, Mr. Hoag purchased 200,000 shares worth $14.5 million. Recently, however, Mr. Hoag has become a seller. On January 30, 2013, after NFLX reported strong fourth quarter results, Mr. Hoag sold 343,400 shares, at a price range of $161.01- $167.68 per share, worth more than $56 million. This transaction is noteworthy for two reasons. Firstly, the size of the transaction, $56 million, means that this is an important transaction. Secondly, Mr. Hoag has proved an excellent NFLX trader over the past few years. In addition to calling the recent bottom, Mr. Hoag also sold NFLX in July 2011 when the stock was trading $268. Simply put, Mr. Hoag is a NFLX insider worth following.

Short Interest Declining

One of the reasons why I was bullish on NFLX was the higher short interest. As of my previous piece, short interest in NFLX stood at 11.64 million shares, or 21.5% of the float. As of the most recent report, March 28, 2013, short interest stood at 7.49 million shares, or 13.8%. Certainly, the short interest is still high, but clearly it is declining. At present, we do not know how much of the post first quarter earnings has been driven by short covering. However, it is likely that the short interest has fallen further as many shorts have been forced to cover. The declining short interest is a negative for two reasons. First, the lower short interest means that the potential for a major short squeeze going forward has been greatly reduced. In fact, I think the short squeeze has already happened. Furthermore, the decreasing short interest indicates that investors are buying into the NFLX bull story and thus, there are less bears left to convert to bulls.

Conclusion

Considering the fact that NFLX shares are up more than 180% since my previous mention, the large inside sale by Mr. Hoag, and the decline in short interest, I think it makes sense to take at least some profits here. Here are 3 possible ways to lock in profits:

1. Sell all or a portion of long holdings.

This is, of course, the most basic way to lock in profits.

2. Buy put options to protect against downside.

Buying put options here on NFLX will provide protection if shares move lower and ensure that profits are locked in. The benefit to this strategy is that if the stock continues to move higher still, investors will participate in the move and simply lose the amount paid for the put options.

3. Sell entire long position and buy some call options

Under this strategy, investors would be able to lock in large gains and still maintain some exposure to NFLX via call options. I would look to use somewhere between 10%- 20% of profits to buy NFLX calls.

Which strategy investors choose is up to them and should be based on individual goals and sophistication. The only mistake, I believe, would be to be greedy and not lock in any profits at these levels.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.