Although the stock looks expensive, an options spread trade on the highflying shares could double your investment within three months.
With the stock at $662, buy Netflix’s September $680 call at $44.55 and sell the September $700 call bid at $35.50. The spread costs $9. For the trade to break even, the stock has to get back to $689 by September.
If Netflix is at $700 by the September expiration, investors will realize a $10.80 profit, or 120% return.
Here’s the trade math: $20 (that’s the spread between the call strike prices) minus the $9 trade cost shows the trade’s potential profit is $10.80. In other words, anyone who does the trade risks $9 to make a $10.80 profit. To figure out the percentage return, divide $10.80 by the $9 trade cost, which equals 120%.
The call spread expresses a view that Netflix trades to a new 52-week high by fall, taking out the June 10 high of $692.79.
If the stock price moved by the time you read this, or you try to model your own trade, simply adjust strike prices to reflect the new reality. Try to keep the 20-point spread, but don’t be wed to the range if you can get a better return using different parameters.
Such a strong move is plausible as Netflix is one of the market’s hottest momentum stocks. So far this year, Netflix is up about 94% at a time when the Standard & Poor’s 500 index is having trouble advancing.
The recommended spread is more than just a momentum trade. At a time when content is king, Netflix, which produces original movies and lets people rent movies, is a content play that lets people watch what they want, when they want, on televisions and computers. Netflix’s valuation reflects its prime position as a major content company. The stock trades at a whopping 186 times fiscal 2016 earnings.
Value investors will cringe at buying anything that trades at a massive premium to the market. But bulls will argue opportunity exists for Netflix to cement the valuation and grow. Needham & Co. analyst Laura Martin raised her price target on Netflix from $600 to $780 on Monday.
The recommended Netflix trade is undeniably aggressive but the risk is limited. Should Netflix stock lose momentum and plummet, all that is lost is the $9 cost of the spread. If Netflix behaves as expected, you will understand why spread strategies are so effective.
(Source by: online.barrons.com)