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Netflix Inc (NFLX) stock is peaking ahead of earnings next month. What should investors do? One thing is for sure - options premiums are high. That could spell high volatility. Shorting deep out-of-the-money (OTM) calls looks attractive here, especially for existing shareholders. Those not yet in NFLX may want to short deep OTM puts.
NFLX is at $708.91 in midday trading on Monday, Sept. 23. This is a peak price for the past 4 years ever since it reached just below $700 in late Oct. 2021.
As a result, options premiums, both on the put and call side, are now very high. I suggested taking advantage of these premiums in my last Barchart article on Sept. 1, “Netflix Stock Is Close to Fair Value - Shorting Options Is the Best Strategy Here.”
How Last Month's Short Options Plays Worked Out
Both out-of-the-money (OTM) trades I discussed worked out. For example, NFLX stock was at $701.35 and I suggested shorting the Sept. 20 expiration $735.00 calls and also shorting the $670 puts.
Both were out-of-the-money between 4.47% and 4.80%. The trade provided OTM short yields of 0.58% (covered call play) and 0.70% (cash-secured short-put play).
So what happened? Since NFLX stock closed at $701.03, the calls and puts were not exercised and the stock was essentially flat during the period.
As a result, it makes sense to roll this trade over. However, it now appears more likely that NFLX stock could take a hit, at least until after earnings are released next month.
Shorting Covered Calls Is Attractive
Existing investors may want to sell out-of-the-money calls at higher prices. For example, the Oct. 18 expiration call options (25 days from now) at the $755 strike price, over 6.26% higher than today's price, trade for $14.95.
That means that an investor at today's price of $708.95 can make an additional 2.1% yield (i.e., $14.95/$708.91). Moreover, if NFLX stock rises to $755 on or before Oct. 18, the investor can make a total return of 8.61% (i.e., $769.95/$708.91).
Of course, that also means the investor gives up any upside over $769.95. That could easily happen if the earnings report surprises the market on the upside.
On the other hand, it's not uncommon for a high-flying tech and media stock like this to “sell on the news.” As a result, investors may want to use a portion of the call options proceeds to buy puts.
OTM Puts Are Attractive As Well
For example, the Oct. 18 put options at the $675.00 strike price trade for $16.65. These are 5.0% below today's price. In other words, if an investor feels that the stock could drop 5% or more they could use the proceeds from covered calls to buy some puts. The $14.95 call premium would cover 90% of the same number of puts as the calls that were shorted.
That way the investor has a way to buy almost free insurance, so to speak, on the downside - at least if NFLX were to fall more than 5% from today's price.
Furthermore, if the investor wants to put up more capital, deeper out-of-the-money put options could be shorted. But I won't get into that here, since this would just complicate the situation.
Keep in mind that if NLFX doesn't look like it's going to fall any further by the last week of this long put play, the investor could always sell these puts to save money. For example, if by Oct. 12, the stock has not fallen, even though earnings are due to come out on Oct. 17, the investor could sell the long put and potentially use those proceeds to buy back the covered call.
The bottom line is that investors can take advantage of high premiums here, especially on the call option side for existing investors. That could help provide some downside protection.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
