Netflix experienced a stellar run in the last month but might be due for a pause. Traders expecting a consolidation in NFLX stock at this level can use a diagonal put spread to profit. Here's how:
Diagonal Put Spread On NFLX Stock
A diagonal put spread is a little more advanced because it utilizes options over different expiration periods and different strike prices. You sell a near-term put for a credit and buy a put with an expiration further out as protection.
In the case of NFLX stock, we could sell a Dec. 15 put with a strike price of 450 trading around 2.40 this morning. At the same time we buy a Dec. 29 put with a strike price of 440, which traded around 2.70.
That puts the net cost of the trade at 30 cents, or multiplied by 100 shares, $30 per contract. This is the most the trade can lose on the upside if NFLX stock shoots up beyond our expectations.
This trade on NFLX stock has a larger risk on the downside. The potential maximum loss is calculated as the difference of the strikes (10) multiplied by 100 shares and adding in the cost of the trade. That comes out to $1,030.
The maximum potential gain is at a close right at 450 on the Dec. 15 expiration. It would be around $430 but that will depend on the implied volatility. The short put would expire worthless, but you would have some increased value on the long put.
Managing The Trade
This diagonal put spread has a nice wide profit zone if NFLX stock finishes between 440 and 480 over the next few weeks.
Aiming for a return of around 10%-15% makes sense, and I would set a similar stop loss.
The worst-case scenario is a sharp drop in NFLX stock early in the trade. For this reason, if the stock drops below 450 in the next few days, I would also consider closing the trade early to minimize losses.
The initial trade setup has a delta of 3, meaning the position is roughly equivalent to owning three shares of NFLX stock. Note that this delta number can change significantly as the stock starts to move.
According to IBD Stock Checkup, NFLX stock is ranked No. 1 in its industry group and has a Composite Rating of 97, an EPS Rating of 85 and a Relative Strength Rating of 94.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
