Netflix, up 47% for the year, has more than doubled gains by both the S&P 500 and Nasdaq. Today's column looks at a pair of long butterfly options trades in Netflix stock.
In less than two weeks, earnings season will be afoot with plenty of news headlines to boot. My premise remains that we sit in a "two-way tape" environment. That is, we expect weekly candlesticks on the stock charts to retrace each other, but also drag either lower or higher.
In the past four weeks, traders in Netflix stock have tried to press higher. For now, NFLX has broken out past a recent cup-without-handle base with a 697.49 proper buy point. The megacap entertainment play is in the 5% buy zone; yet Netflix stock has not made a new high in recent sessions.
Netflix's third-quarter earnings are due Oct. 17. We can reasonably expect a sizable move on the horizon, even before the earnings report. Thus, with the possibility of the market "tape" going two ways, we position in both directions with the butterfly spread trade.
We must consider our position size and lean into a smaller trade. Why? The trade probabilities are slanted away from us. So, when shocks come, we are well rewarded by this options strategy. But when the moves in Netflix stock prove undersized, we do not get penalized heavily.
As always, assume we don't know the direction. But we can still estimate the magnitude of the Netflix stock move using ATR (average true range) on the weekly chart. We also consider the implied moves that market makers have priced in over the months ahead.
Netflix Stock: The Trade
Let's position a long call butterfly so the 'long wing' of the trade gives us a likelihood of returns. Use the short wing, or the sold call spread, to finance part of the trade.
The long call butterfly comprises a long call spread (a bullish position) and a short call spread (a bearish position) in Netflix stock. Both spreads share the middle strike price, or in this case 805.
- Buy to open one NFLX Nov. 15-expiring 790 call
- Sell to open two NFLX Nov. 15 805 calls
- Buy to open one NFLX Nov. 15 820 call
The call butterfly above will cost approximately $0.43. This means the maximum loss in this spread is $43 per set of contracts. It also makes the max profit $14.57, or $1,457, before commissions. Total profits will begin to erode if the price of NFLX stays above 805.
Set The Put Spreads
Now, the long put butterfly. Let's position it in Netflix stock so the 'long wing' of the trade gives us a likelihood of returns. Again, use the short wing to finance part of the trade.
The long put butterfly is a long put spread (a bearish position) and a short put spread (a bullish position). They share the middle strike price.
- Buy to open one NFLX Nov. 15 670 put
- Sell to open two NFLX Nov. 15 655 puts
- Buy to open one NFLX Nov. 15 640 put
The put butterfly above will cost 75 cents. Maximum profit potential is $14.25. Total profits will begin to erode if NFLX stock stays below 650.
So, if we take both sides of these trades, we see a maximum exposure of around $1.18 ($118 per set of contracts. This opens room for a maximum profit of up to $13.82, or $1,382 per set of spreads. We typically look for 20%-40% of the maximum profit as a target zone to complete the trade.
Defending The Trade
Stock hunting using fundamental and price strength within The IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
The goal of taking long butterflies? Take advantage of higher implied volatility as the undercurrent of markets shifts, and we can then participate in an outsized move in either direction.
The relative resistance zone for Netflix stock sits right around 775. This level likely brings in sellers if rotation continues. Evaluate the position at the test of 775. The big round number of 800 could easily become a magnet. Support sits near 660; we could see heavy buying near this region over many months.
Netflix Stock Exit Strategy: Three Choices
The strategy result provides three choices to exit the trade in Netflix stock. One, sell both butterfly spreads once the middle strike of either spread is tested. This means we look at setting an alert for 800 (to appraise behavior and profit) and 805 to cover the call side. We also set an alert at 670 and 655, or the middle strike price, to cover the put spreads. We are looking for either butterfly to deliver the positive overall result. Two, sell the spread once it hits your loss threshold as determined by personal risk. Three, sell the first spread that hits its middle strike and leave the opposing spread to recover if market gyrations continue.
Finally, sell the Netflix stock spreads into the week before expiration, if all is going well and you have decided to hold the trade closer to the end of expiration. But I have had many a trade go sideways taking it down to the wire and not capturing gains, so I do not advise this.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on X at @AnneMarieTrades
