Netflix: Blasting Out Of The Perimeter; Proceed North In A Calculated Manner

| About: Netflix, Inc. (NFLX)

Summary

ER came in significantly higher than forecast and showed growth is now better in line with management's estimates.

Price jump of nearly 20% though is likely more based on relief from a good quarter that exceeded a low bar set after three dismal quarters.

Now after breaking the $100 "Pusan Perimeter" with force, assessing and planning for one’s next move on the stock is prudent.

A month ago I published an article showing Netflix (NASDAQ:NFLX) had been seeing difficulties in sustaining a breakout above its $100 "Pusan Perimeter" of the past nine months. This week, NFLX got its "Inchon Landing" with the latest ER and broke through this line. Bottom line was that subs exceeded expectations, significantly on the international side, and EPS was double the expectation. In that last article, I said I was staying away and could see the potential for a replay of the previous three quarters, but that it seemed like any price movement would be less dramatic. The situation seemed hazy for the ER in mid-September even with a low bar set by management.

I then headed back to the U.S. for a few weeks and began to catch back up on NFLX news in early October. What I saw surprised me as several pieces of information changed my perspective and called me back for a couple trades:

1. The rumor mill began running rampant on potential acquisition actions by Disney (NYSE:DIS) or Apple (NASDAQ:AAPL). While I felt TWTR at the time had a possible, but improbable chance of acquisition with its own number of M&A rumors swirling concurrently, with NFLX this was just ridiculous talk. I'm not saying NFLX would not fit well with the likes of either company, but the price and timing was wrong. It would have required a price of $130-150 (now more like $155-180) and it would have been occurring right around a fresh release of quarterly results - and they could not be that bad. So I went short with just a few November puts bought at ~$105 for $3.24, and sold just over a week later when the stock dipped back to $100 for $4.20 - a 26% gain after commissions.

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2. Then earnings day came about with the stock trading at ~101.50 Monday morning (as I was going to bed here). Research over the past couple days since returning home had led me to a newfound bullish premonition. First, the bar was set far too low for NFLX to not meet. Second, the teen survey came out for Piper Jaffray that showed strong support in youth for NFLX. And third, Max Greve published this article that mirrored my newfound bullish sentiment that NFLX's stock. It was beginning to look like a coiled spring ready to exit a jack-in-the-box, at least in the near term. Everyone was just too negative. While I still saw NFLX as risky, the puts and calls were well-priced to only require an 11% move to breakeven for a weekly straddle - a move I assessed NFLX could easily exceed one way or the other. Thirty minutes before market close, I awakened in northeast Asia (430am) and immediately picked up three calls and puts at the $100 mark for $5.45 each. Tuesday, I exited all the positions for a 60% overall profit.

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So What Now?

But now NFLX sits at about $119, with a definitive breakout through a point that has haunted it for the last nine months - so where does it go from here?

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I don't have a crystal ball, so I won't try to say it will double in four years, nor will I say it won't. But there are several lessons learned from the real Korean War breakout of the Pusan Perimeter that might help investors in this situation: Assess your gains, know your end-state, war-game your next move, and make calculated decisions that lessen risk.

Assess Your Gains

I am not arguing NFLX cannot continue north, but eventually it will have to capitulate climbing higher for a bit and likely sell off a bit. Like Max and Orange Peel Investments, I see a dip in the near future, but unlikely back to $100 or less unless a general market decline occurs. But if you return to the Korean War, gains were not really assessed by UN forces after breaking north. Stopping at the 38th parallel would have been an adequate gain had it not been for a contentious decision to reunite the Peninsula. Sometimes one most know when to take a profit and be happy. At this point, pruning holdings or hedging may be a prudent decision.

Know Your End-State

To make money…yes, I know this is the final end-state, but what is enough? Many have learned lessons during boom and bust that having some type of escape plan to take some money off the table is a wise decision. Investors at this point, especially those who have been in NFLX for the long term or want to be, need to really ask what they want this stock to do in their portfolios. Going back to the Korean War, the end-state was muddled - was it to stop aggression or reunite the two Koreas? Not having a solid and conjoined end-state and extending too far pulled in Chinese support that extended the war over two years. So in a stock like NFLX, deciding your ultimate goal for the stock and the percentage it should be in your portfolio now can help drive when to sell, hedge, or buy more. If you are BuyandHold2012, that sell point is never. However, he would also never be caught dead in NFLX with its PE ratio. But this is a rational question that after a 20% pop should be asked.

War-game Your Next Move

NFLX's volatility means investors must be ready to act quickly. Reflect now while the stock is up and the coffers are full on what is the next action. It may be to do nothing, but war-gaming is an opportunity to identify which indicators will signal your next move and play out the results. Research, prep and understanding the environment will lead to disciplined investing, which helps keep the hype of NFLX at bay and thus avoid paying an excessive price. Going back to Korea, war-gaming lacked in the advance to the Yalu River, and ignoring signals caused UN troops to be caught flat-footed by the Chinese entry into the conflict - something an investor never wants to experience with a stock.

Make Calculated Decisions that Lessen Risk

With this said, NFLX has done well and it likely will remain above the $100 mark for some time, barring a major market decline. But risk can be even further diminished through calculated decisions that don't fight the tape. Shorting a near-term fade will likely be a good short-term trade if the stock breaks into the $120s, but I would recommend doing it with puts to reduce overall risk. If one is long, reducing risk can be had by selling covered calls to hedge or pruning shares with this recent significant gain, which might be advisable. At the $118+ mark, I see the risk to reward as too high to buy additional shares right now and would rather wait for a dip back to under $110 to re-enter.

Conclusion

NFLX is likely going to remain a volatile stock for the next few weeks and is worth monitoring for dips. At this price, I will await a dip to re-enter as the dust settles from the ER, and this stock will never be a significant portion (over 2%) of my entire portfolio. The stickiness of the brand is well embedded and growing globally. Thus it remains an opportunity to own at the right price. On a personal note, I have continued to see solid content churn even overseas which does lead me to believe much of this recent climb in price is here to stay as it was accompanied by strong international growth in subscriptions.

With that said, I wish everyone the best of luck and thank you taking the time to read. If you would like to follow my writings, just click the follow button next to my name at the top. Thanks again - Cheers!

Disclaimer: I am not a financial professional and accept no responsibility for any investment decisions a reader makes. This article is presented for information purposes only. Furthermore, the figures cited here are the product of the author's own research and may differ from those of other analysts. Always do your own due diligence when researching potential investments.

Disclosure: I am/we are long AAPL.

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.