Netflix: House of Consolidation?

Update On July 08, 2014 at 9:12 AM
Ok with NFLX pulled back so significantly today I'm closing my IC today for $32.6 each. Yesterday I had closed the hedge for $12.3.

IC Closed at $32.6 (today)
Strangle (hedge) closed at $12.3 (yesterday)
NET STRUCTURE SALE PRICE = $20.3
COST PRICE = $31.35 

OVERALL PROFIT = 30.8%

Update On July 07, 2014 at 11:20 AM
Looks like NFLX might be pulling back a bit as the "weak hands" are taking profits before the earning season begins. That doesn't mean this thing cant pop right back, but I do expect a bit more selling, so for now i'm going to sell my Strangle (hedge) for $4.1 each (bought for $1.75 each) for a total of $12.3. Will continue to hold the IC and sell it on any pullback.

Update On July 01, 2014 at 08:34 AM
The timing of our Strangle hedge yesterday turned out to be really good - but in hindsight we just got lucky. 
The IC is currently down around 30%, however the Strangle that we purchased for $1.75 each (see yesterdays comment below) is worth $6.5 each which is a gain of 27.5% on the overall portfolio, hence making the whole structure down around 2.5%. I will continue to hold the position for now.
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Update On June 30, 2014 at 11:41 AM
One of the ways I like to hedge my IC's is by buying a strangle (a long call and a long put) for 15% value of the IC. This minimizes my loses in case the stock has a sudden move in either direction as the loss in IC could be (to some extent) negated by the gain in the strangle. I put the hedge on usually at the same time as the IC since I sell 3 weeks out - but in this case I chose to wait until today since I sold 5 weeks prior.

Now that my trade is up 5%, I want to spend 15% of the value of IC to buy a $340/$480 Strangle for $1.75 each
If I had 1 contract of the IC, then I would buy 3 contracts of the Strangle.

Buy 3 $340 put for $0.15
Buy 3 $480 call for $1.6

Credit from IC = $36.6
Debit from Strangle =  $5.25 
NEW COST OF STRUCTURE = $31.35 Credit

If NFLX remains range bound, the IC will gain value but the Strangle (hedge) will lose value which is exactly what we want. We give up a little bit of profits using this method to buy protection from any unexpected moves.
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Update On June 26, 2014 at 10:24 AM
Up one day, Down the next day...this is what consolidation looks like. While it's frustrating for long premium plays - it's great if you have sold premium and betting that market makers are right this time. 

So far, the stock is acting as per the original thesis I laid out.....consolidating and pulling back slightly in response to the overhead supply. If the stock continues to come it, it will greatly help the trade. For now, I continue to hold. 
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Update On June 19, 2014 at 12:38 PM
Update: Still holding the trade. The real risk would be a big gap up above $360 because that might cause a short squeeze and push the stock even higher. Typically if a stock has climbed an almost straight line of 50% in such a short amount of time...it needs time to refresh itself before it regains it's mojo. So I still think sideways to slightly downward is my bias and i continue to play with the IC outlined above. 
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Update On June 13, 2014 at 9:50 AM
2 days after I put on the trade, it is working as expected. There has been a $5 pull back in the stock and my Iron Condor structure is up by $2.3 which equals 6.2% in profits. 
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NFLX never fails to entertain – whether it’s the streaming service or the stock itself. It plunged from it’s all time high of $458 to $300 (35%) only to jump right back to 430 (43%) – all in a span of just 3 months. While it would take a classic tarot reader to predict the stocks next 40% move….the charts do leave us with some clues. If you look at NFLX weekly chart and draw a vertical line around end of April timeframe – the stocks fall and recent rise looks like a complete mirror image – and I think therein lies the important clue to the stocks next move.

The stock’s recent straight line move from $300 to $430 has been nothing less than excessive leaving most technical indicators in overbought territory. The whale has had a big meal and needs time to digest it. People who bought it at this level 3 months back (prior to the big plunge) are happy to take their money and run. The more lucky ones who picked it up at lower levels are sitting on a nice profit & will get out on the first signs of a pullback. On the flip side, new buyers are hoping for a sell off so they can get in and ride the next wave higher. This situation creates a perfect dead-lock between the bulls and the bears – which should keep the stock mostly range bound for the next few weeks.

Selling options has been one of my favorite strategies since I started trading options 10 years ago and in my experience Iron Condors offer a decent probability of success in scenarios like this where the stock has had an excessive move and is expected to consolidate as the stock changes hands between old buyers and new ones. Put it all together, here is the structure that I’m going with:

NFLX ($429.95) July 2014 Expiration 335/410/410/485 Iron Condor for a credit of $36.6

-          Buy 1 July 19^th $335 Put for $0.86

-          Sell 1 July 19^th $410 Put for $10.9

-          Sell 1 July 19^th $410 Call for $29.5

-          Buy 1 July 19^th $485 Call for $2.95

If by July 19^th Expiration the stock is between $373.4 and $446.6 then this structure will make money. Max Profit potential is 95%. Profit Target is 25%  and Loss Exit Target is 30%

Why did I chose this structure? I have 3 key risks and here is how I chose to mitigate them:

• Stock moves too much to the downside: This is a real risk as profit taking can quickly take this thing back to 390. Although I do think any sell off will be short lived and new buyers will likely push it right back to current levels, but depending upon the sell-off (if and when it happens), I might consider buying some out of money puts to protect myself from a major down side. My strike selection of $410 is about $18 below the current stock level to account for this risk.

• Stock moves too much to the upside: This seems a bit less of a risk considering the 43% rise in such a short amount of time without any real correction. I think the best thing that can happen for this structure is that the stock continues to go up in a straight line, because then the likelihood of it hitting the 450-ish resistance and then pulling back hard to 400 level over the next few weeks would be very high which would work out very well for our structure.

• Stock volatility shoots up: The stock volatility would likely shoot up if the stock has a sharp drop, so this risk is linked to the 1^st one I mentioned above – which is another reason why I decided to go with the $410 strike as midpoint so that if the stock falls $20 points then the rise in volatility will be more than offset by the reduced price of the structure (since stock will be at the structure midpoint)

I typically prefer to sell options 1 month out to enjoy the rapid decay, however I’m going with July expiration in this case because NFLX is highly volatile so I want to have a little extra premium collection that gives  me that extra safety cushion. In addition, the bid/ask for other expirations is too wide which I don’t like.

The last time $NFLX had an excessive move from $320 to $430 level back in March, the stock consolidated for a good 6 weeks (see blue rectangle below). Same thing happened when it fell to $300 in April - stock consolidated for few weeks - although range was wider (typical of a bottoming action which is different from a topping action) - which is why I think going out 6 weeks with a 30% loss threshold gives us the tolerance we need to hold through any temporary turbulence while it consolidates.

I think NFLX is in a sweet spot where the bulls and bears will go back and forth on it for a while which would result in premium erosion that could prove to be an amazing opportunity to sell options that are not necessarily too cheap.