Netflix formed a cup base over the last eight weeks and is finding support at its 50-day line. But with the back-and-forth of the current market, maybe a neutral outlook on Netflix stock is appropriate here. That's where a calendar spread could be useful.
Calendar Spread Has Neutral Outlook
A calendar spread is a trade that involves selling a short-term option and buying a longer-term option with the same strike price.
The near-term option benefits from time decay and the longer-term option defines the risk in case Netflix stock moves away from the strike price.
Usually the calendar spread uses monthly options, but weekly options work as well.
Traders typically use call options unless the trade has a bearish bias. In that case, puts are more appropriate.
Setting Up The Calendar Spread On Netflix Stock
With Netflix stock trading around 338, setting up a calendar spread at 340 gives the trade a neutral outlook.
Selling the April 21, 340-strike put option generates around $1,750 in premium. Buying the June 16, 340-strike put costs around $2,640.
That results in a net cost for the trade of $890 per spread ($2,640-$1,750). This is also the most the trade can lose.
The estimated maximum profit is around $1,500, but that could vary depending on changes in implied volatility.
The idea with the trade is that if NFLX stock remains around 340 for the next few weeks, the sold option will decay at a faster rate than the bought option.
Finishing at the strike price at expiration gives you the maximum profit. It's where the difference between the option prices is greatest since the sold option expires worthless while the long option will have the most time value.
Managing The Trade
The break-even prices for the trade are estimated at around 305 and 392, but like the maximum profit these can change depending on the impact of implied volatility.
Using options in this way can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
For this reason, calendar spreads are considered a more advanced strategy and not recommended for beginners.
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For a trade like this I would set a profit target of 20% and I would set a stop loss if NFLX stock breaks through either 305 or 392.
I also limit my risk to just 2% to 3% of my capital.
According to the IBD Stock Checkup, Netflix stock ranks No. 1 in its group and has a Composite Rating of 94, an EPS Rating of 70 and a Relative Strength Rating of 94.
Netflix is due to report earnings on April 18, so this trade would have exposure to earnings if held through that date.
This isn't the only trade recently analyzed for Netflix stock in the column. A broken wing butterfly trade on NFLX stock looks unlikely to get into the profit zone. It can still be closed for a roughly 4% gain though.
Remember that options are risky and investors can lose 100% of their investment.
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
