Is it Time to Short Netflix Stock?

 

The Fundamentals – Is it Time to Short Netflix Stock?

There is a lot to like on Netflix, and it costs just $7 a month.  On October 17th the company released earnings per share of $0.12 versus the expected of $0.06, a 100% surprise beat!

The great news did not stop there – the company announced revenue increase of 36% from a year earlier and 3.4 million subscribers versus an expected 2.4 million.  We get it, the company is on fire and investors are feeling upbeat.

But looking at the fundamentals sheet below we can see that the company is trading at a whopping 331x it’s earnings.

Would you pay $2,317  a month to watch movies?  (331 x $7)

That is the premium you are paying to own the stock as of today.  Said differently, at this pace of company profitability it would take Netflix 331 years to be worth $126 per share.  We know that it is a growth stock, but 331x earnings?  How much premium are you comfortable paying to gain growth potential?

netflix-fundamentals

 

The Technicals – Is it Time to Short Netflix Stock?

Since the earnings beat, Netflix stock has jumped over 8%  in 4 days on a total of 88 million shares traded.  That means on average, 22 million shares were purchased daily, compared to a pre-earnings average of just over 9 million shares daily.

What does all this mean?  It means a pile of retail and institutional traders might now be trapped traders at the highest prices of the year.

It means it is probably time to short netflix stock – soon, but not right away.

Looking at the daily chart below, we can make a few observations on the timing of shorting Netflix stock:

  • Volume has consistently declined as prices have rallied (suggesting buying momentum is slowing down)
  • Momentum has hit over-bought levels, although they can hang out in that zone for a long time (indicators should never get you in a trade, but help keep you out)
  • Price is now 27% above the 100 day and 200 day moving averages – a common reversal point is 30% to 35%

 

Options Trade Idea to Short Netflix Stock

When you are shaving against the grain, you can expect to get a few cuts, but for the cost you get the closest shave possible.

Same idea with trading, shorting Netflix stock at this price is going against the grain, but it is a much safer trade than buying it at this price as contradictory as that may feel.  Most investors buy high, and sell low.  Traders like to either fade or trade momentum – this is a fade trade.

This is an option spread we are exploring:

Buy 130 Nov 25th NFLX Put Option = $765 per contract cost

Sell 117 Nov 25th NFLX Put Option = $323 premium collected

Net Cost: $442 / contract

 

Risk and Return Profile

Max Loss = $442 / contract (when NFLX trades higher than $130 by Nov 25th)

Max Profit = $858 / contract (when NFLX trades at or lower than $117 by Nov 25th)

Risking $442 to make $858 is a 1.94 to 1 ratio.  As long as we have a 50% success rate in our analysis, this is a good trade.

 

The best part about this options trade is that you can decide to cut your losses and get rid of the trade before your max loss occurs, just monitor the options spread price and you can even set a stop or snap mid order (click here to learn more about using snap mid orders).

 

Conclusion – Is it Time to Short Netflix Stock?

At the end of the day the decision as an investor and trader is 100% yours.  This is a business that rewards risk management, discipline and execution.  I always tell our traders that any trade can make sense as long as you have good risk to reward ratios and know when you will exit before you get in so you don’t get stuck holding the bag.

Fall in love with your significant other, not stocks.

We will be getting short Netflix in the coming few days, but are not yet in the trade.  We are waiting for a little more confirmation before we pull the trigger to short Netflix stock.

 

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The information contained in this post is solely for educational purposes, and does not constitute investment advice.  The risk of trading in securities markets can be substantial.  You should carefully consider  if engaging in such activity is suitable to your own financial situation.  TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.