They say a picture is worth a 1,000 words. Well, in option trading, sometimes a picture is worth thousands of dollars.
We have been covering Netflix (NFLX, $77.69, down $41.15) for a few years now and it was stock we have played options on quite regularly until it moved into triple-digits back in August 2010. We began coverage of the stock when shares where near $50 in 2009 and over the summer Netflix hit a high of $304-and change.
The stock’s move from $50 to $300 is one of the reasons we started our covered call portfolio because there are still great growth plays out there and it was a stock we wanted to hold. However, as we have seen with many high-flyers over the years, when there is a chink in the armor, or a misstep in management, or a product delay, or a setback in the clinical development of a drug, shares can get hammered when something goes wrong.
Netflix is Wall Street’s latest darling to fall from grace after the company reported a fantastic quarter, but lowered 4Q guidance and said it could possibly lose money for all of 2012. Profits came in at $62 million or $1.16 a share, which was well ahead of estimates for 96 cents a share. Revenue for the quarter was $822 million versus forecasts for $812.5 million. That was the good news.
The bad news is that Netflix now expects 4Q 2011 earnings of 36-70 cents a shares on sales of $816-$845 million. Talk about a range pro golfers would envy…
Of course, some of Wall Street’s “analysts” have issued sell ratings on the stock today but we showed you this chart on September 30, 2011 with a possible $75 price target (blue line):
As you can see, our chart work was spot on but we stayed on the sidelines because of the high option premiums for the November puts. Even the WEEKLY options on Netflix commanded a high premium. With Netflix nearing $120 into yesterday’s close, we looked at the October 100 puts (NFLX111028P00100000, $24.80, up $22.50), which were at $2.30, and a drop to $95 would have meant a double as the puts would have been worth at least $5. Well, today’s drop to $75 pushed these options up 965%.
There was also the chance shares could’ve rallied if the company would have said something really, really swell about their growth going forward. As insurance, we also looked at the October 140 calls (NFLX111028C00140000, $0.00, down $2.25) which were at $2.25 going into the close. Needless to say, these options will expire worthless on Friday.
The risk of this trade was that shares needed to move 20% or more AND there was a chance shares could have stayed flat or only moved a little which would have deflated the premiums. In any event, it would have cost $5 round-trip and it didn’t make sense for us to risk so much when there are other trades working right now.
In other words, we didn’t like the risk/ reward of making it a strangle trade but it would have been a HUGE winner either way. Although we didn’t make this an official trade recommendation, some of our subscribers are happy we had Netflix on our Watch List last week.
As far as the market today, we are getting a test back down to support which was prior resistance. There are now worries Europe might not be able to pull things off by Wednesday. Imagine that.
The Dow is down 102 points to 11,810 while the S&P is off by 13 points to 1,241. The Nasdaq is lower by 34 points to 2,665. The S&P Volatility Index (VIX, 30.60, up $1.34) has popped back over 30. Subscribers, check the Members Area for the updates.
We have another Profit Alert for one of two more of our trades which are up 45% and 88%. Let’s ring the register on our 19th and 20th-straight winning trade! Subscribers, check the Members Area for the updates.