Make A Prudent And Profitable Bet On Netflix With Options Trades

Sep. 2.11 | About: Netflix, Inc. (NFLX)

Netflix Inc. (NASDAQ:NFLX) has certainly been an interesting show to watch of late. After jumping more than 50% over the past year and nearly 1,000% since its initial public offering, the online movie provider has started a downward spiral. The stock hit a high of $300 per share this July, but subsequently shed nearly 30% to reach its current price of around $212 per share.

Here, we’ll take a look at some popular opinions of where the stock may be headed, and then create a strategy using options to optimize a bet for both long and short investors.

Skeptics Predict a Fall from Glory

Many experts have been skeptical of the company’s ability to grow much larger. While the company still houses perhaps the largest collection of movies and television shows, there is growing concern in Hollywood about its clout that has caused some friction. And, it’s new pricing model hasn’t helped in easing investor concerns over its ability to increase its subscriber base to drive growth.

The company’s competition continues to grow, and includes:

  • The Walt Disney Co. (NYSE:DIS), News Corp. (NASDAQ:NWS) and NBC Universal’s jointly owned, which is soaring in popularity, particularly for television shows.
  • Inc. (NASDAQ:AMZN): Amazon Prime is now offering more than 100,000 movies and TV shows for purchase or rent using its Instant Video service.
  • Apple Inc.’s (NASDAQ:AAPL) iTunes is already a large and growing player with a nicely integrated platform for future TV hardware products and existing music devices.
  • Dish Network Corp. (NASDAQ:DISH) is reportedly planning on launching its own online subscription video service or expanding its nascent ones.
  • Coinstar Inc.’s (NASDAQ:CSTR) Redbox has more than 25,000 kiosks for customers to rent and pick up movies at a very low cost.

In what some are calling the writing on the wall, Starz Entertainment ended its contract renewal negotiations with the company this week, and will cease to distribute its content on the Netflix streaming platform. The contract included more than 1,000 Sony Corporation (NYSE:SNE) and Disney titles per year. Combined with the potential for subscriber loss, many investors are feeling worried.

Finally, there’s the company’s valuation. A price-earnings multiple of more than 50x its trailing 12-month earnings suggests that investors are expecting continued significant growth. And, compared to companies like Apple, with a P/E of 15x, and Google (NASDAQ:GOOG), with a P/E of 19x, it could be overvalued. Some investors believe that the above catalysts could spark a multiple decline.

Options for Prudent Long Investors

Investors looking to ride the short-term storm in hopes of long-term success may want to do so prudently given the above arguments. The most common strategy to reduce exposure to a long position using options is the covered call. By writing out-of-the-money call options, investors can collect premiums that can be then used to offset the total capital invested, thereby lowering risk.

Currently, investors can write 300 October 2011 calls for a $0.71 per contract premium – or $71 for every 100 shares. Alternatively, 300 December 2011 calls can be written for $2.85 per contract – or $285 for each 100 shares owned. While these may seem like small amounts, written over time, they can accumulate into significantly offsetting premiums.

Options for Shorts to Avoid Getting Burned

Investors looking to take a bearish position in Netflix may want to avoid short-selling the stock. Short-selling involves using leverage and entails unlimited losses. After the stock’s 30% drop since July, some argue that the bearish news is already priced into the name. As a result, these investors may want to consider a more prudent options strategy to avoid being burned.

The simplest options strategy in this case is purchasing long-term puts. The at-the-money 210 January 2013 LEAPS puts trade at around $47.10 per contract. This means that the stock would have to drop to about $162.90 before January 18, 2013 to become profitable. At around a 22% drop, this is not out of the realm of possibilities, while the total amount at risk is just $4,710.

A more complicated strategy may be to create a reverse diagonal spread. After purchasing the long-term at-the-money 210 January 2013 LEAPS puts, the investor could then write shorter-term out-of-the-money puts and collect the premiums. Similar to the covered call strategy, but with a longer-term option substituting for actual stock, the investor collects additional funds over time to lower his/her exposure.


Netflix is facing various headwinds over the coming quarters. That uncertainty has led its stock to drop more than 30% off of its highs in July. Both long and short investors should be careful before putting money into this name due to this uncertainty. Using the aforementioned options strategies, investors can make more prudent bets that can protect their interests in the event of an unexpected outcome.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.