Netflix in a Bad Spot Right Now

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In a new Piper Jaffray analyst report, Netflix just lost its top spot among teenagers. For the first time since streaming services began taking off, Netflix is watched by fewer viewers than YouTube.

While the Google-owned video service does offer pay-per-view options, its crowd-sourced content has put it over the edge:

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Obviously, Netflix’s one-third market share with this key demographic is still impressive. With so many options for teenager’s eyes, one in three still tunes in.

But as these falling numbers come at a time when many more options are about to come online – including Apple’s streaming service and the much-anticipated Disney+ — things don’t look great.

And there’s really nothing Netflix can do about it. Competition will continue to tick up. And unless it significantly diverts its efforts toward influencers and smaller content creators, the next generation of viewers is going to continue dropping off.

Now, this might not seem that disastrous. After all, teens aren’t the largest spenders. But there’s a trickle-down effect.

While Netflix doesn’t have to compete with YouTube for advertising revenue, it does have to keep these teens’ parents to continue to subscribe to profit.

If those real subscribers see better offerings with alternative services – like the aforementioned Disney, Apple, CBS, etc. – and their kids aren’t watching Netflix, the company’s subscriber growth trend could face significant headwinds.

This is especially true as the economy continues to look weak and consumers start budgeting more.

Of course, this isn’t a brand-new problem for Netflix. While the Jaffray report is troubling, it isn’t the first of its kind. Investors have seen these problems begin to mount for a while. As you can see, shares have tumbled significantly over the last several months:

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The real issue is that NFLX’s share price has been locked in a terrible downtrend for nearly six months. And it has fallen through all of its supports.

Since late July, the stock has traded downward between its trendline and its 20-day moving average, abandoning its 50 and 200-day MAs a while ago.

The next level of support is all the way down at its recent lows of $250 or even its end-of-2018 prices around $230. Now, I’m not suggesting it is due to fall that low. But a turnaround isn’t really on the table anytime soon.

Fortunately, there’s money to be made from its current situation without needing to bet on extended losses. For us, there’s a perfect trading strategy to play this year-end weakness.

A Strategy For Short Term Bears

A bear call spread is a type of options trade that profits even if shares don’t fall. It is a bear trade, in that it does best when shares don’t go up. But they don’t need to collapse either.

The way it works is by selling a near-the-money call option (ideally one with a strike price just above the current trading price of the underlying) and buying an out-of-the-money call.

This results in a net credit to the trader’s account. Meaning, this trade pays him upfront for opening it. Now, it does come with some risk… of course.

That initial credit is his total profit potential. It’s his as long as shares either move sideways or down, which his definitely more likely for NFLX right now. But if shares do go up, this kind of trade can turn to a loss.

You can see the risk-reward outcome of a bear call spread here:


Source: InvestorsObserver

Now, with Netflix trading at the high end of its trading range – which as mentioned is downward sloping – a near-term drop is definitely likely. But with its recent trading action, this strategy actually works out to a more profitable setup than buying puts does.

Let’s look at a specific bear call spread to see by just how much…

A Specific Trade on NFLX

Right now, shares of Netflix go for $275 each. So, to enter this trade, that’s where we’ll start.

A trader can sell a November 15 $275 call on NFLX for $18.23 per share and buy a November 15 $280 call for $15.85 for a net credit of $2.38 per share. Since each contract is for 100 shares of NFLX, that’s an income of $238 to open this trade.

Now, that’s the total profit the trader could get from this trade. But as long as shares of Netflix remain weak for the next few weeks – which they definitely should – it’s his to keep.

The risk side of this would come if shares somehow rebound from here. The only way for this to happen, however, would be some mega news story like Disney delaying or canceling its streaming service. Again, virtually impossible at this point.

Nonetheless, to find out how much of risk this trade carries, take the difference in strike prices ($280 – $275 = $5), and subtract the initial credit ($5 – $2.38 = $2.62). Again, on 100 shares of NFLX, that’s $262 in total risk. But as noted, shares would have to seriously rebound for that to happen.

In other words, if shares fall or simply stay flat, this trade would end with a 91% return on risk. And again, to capture that full amount, shares don’t have to move a penny from where they are… let alone continue falling like they most likely will.

While you could go out and buy puts on NFLX or short the stock directly, both carry much higher cost and risk. This strategy offers a conservative way to capture a clear downtrend for a company that is in trouble, but not in imminent danger.

None of this is to say Netflix can’t recover, or it is set to continue spiraling down. Eventually, the tide will turn. It is, after all, still a growing company. But for the next six weeks, this downtrend has further to go. And using this bear call spread strategy is the best way to play it.

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