Netflix is due to report earnings on Tuesday after the market close and the options market is pricing in a potential 8% move in either direction.
Let's analyze how we can structure an option trade that fits the view that
- We think NFLX stock will stay within the expected range.
- The response to the earnings report is likely to be positive.
Using Expected Range To Pick Strikes
Taking the at-the-money put and call for the Jan. 24 expiration gives us a good idea of what the option market expects from earnings. We add those up for a total combined premium of roughly 71. With Netflix trading around 871 today, that means it has an expected range just over 8% by the end of the week.
Now that we know the expected range, let's find a bull put spread that has a breakeven price roughly around the lower end of the expected range.
We'll start by selling a Jan. 24, 800 put and buying the 795 put to create a bull put spread.
This spread is trading for around 95 cents today. That means a trader selling this spread would receive $95 in option premium and would have a maximum risk of $405.
That represents a 23.5% return on risk between now and the end of the week if NFLX stock remains above 800.
If Netflix stock closes below 795 on the expiration date the trade loses the full $405.
Netflix Earnings Leave Little Room For Adjustment
The breakeven point for the bull put spread is 799.05 which is calculated as the short strike of 800 less the 95 cents option premium per contract.
There is little room for adjustment with short-term trades such as this, held over earnings. Once the earnings report is out the move is pretty much done as there isn't much time before expiration.
A 23.5% return in a few days would be nice, but the possibility of losing 100% is also very real.
As such, this style of trade is only for traders with a high-risk tolerance and a bullish outlook for Netflix stock.
A Follow Up To A Previous Earnings Trade
According to the IBD Stock Checkup, Netflix ranks No. 1 in its industry group. It has a Composite Rating of 98, an EPS Rating of 98 and a Relative Strength Rating of 91.
As a follow-up, last week's earnings bull put spread trade on JPMorgan Chase expired worthless. That was the best case scenario for the credit spread, meaning it achieved full profit.
It's important to 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 X/Twitter at @OptiontradinIQ
