The streaming wars are heating up. But as we all know, it’s tough to take down the current champion in any field.
Between Disney’s Disney+, AT&T’s market-grabbing three-tiered streaming plans and Amazon’s Prime Video, Netflix has some competition on the horizon.
It’s remarkable how many new players are entering the field now. That overused term “cutting the cable” is back on everyone’s lips… and for good reason. No longer is it just Hulu and Netflix in a battle over streaming dominance.
All come into this battle with formidable plans. Disney owns Fox and therefore much of Hulu. AT&T’s industry-shattering acquisition of Time Warner gives it a large chunk of content priority. And even CBS is trying its best to compete with its own CBS All Access.
The landscape, it is clear, is changing. But Netflix remains the top dog. It has an audience that spans every generation. It has led this field from day one, when it was still sending out DVDs and destroying brick-and-mortar Blockbusters.
The company has since moved on from acquiring licenses to creating its own content. That was a move almost no one expected to go well. But it paved the way forward well, with Amazon taking up its own role in production.
So, with all of this competition, it shouldn’t come as a complete surprise that Netflix has been on a bit of a break with investors the past few months:
Falling by more than $130 per share in just six months isn’t a good look for any company. But it’s important to remember how NFLX got to $400-plus per share in the first place:
The first was a daily chart. This second one is its weekly chart. If there was ever a case of investors having two minds about something this obvious, we haven’t seen it.
Of course, when investors make such rash decisions, it does typically lead to opportunities for the more levelheaded of people. So, before we conclude anything, let’s look at some real facts about the company.
The Number’s Check Out
It’s important to put Netflix’s long-term stock rise in perspective. It is a meteoric rise due to the company’s underlying meteoric performance. Four years ago, the company had a gross profit of $1.8 billion. Over the last 12 months, the company grossed $5.9 billion. That’s a compound annual growth rate of 35%. Good luck finding that anywhere else.
Secondly, this performance hasn’t been in isolation as the only streaming option for customers. Hulu and Amazon have already been in the space for a long time… gaining at similar clips.
The reason all of these streaming services have been able to grow at such rates has little to do with their own competition. It’s simply because of the enormous pool of cable-cutting customers.
Just this most recent quarter, Frontier lost 37,000 video customers. Comcast dropped 95,000 customers. And Charter’s video subscribers fell 66,000. All of these customers are finding replacements in the likes of Netflix, which saw a rise of 7 million customers during the third quarter.
Think about that. The company that saw 7 million new people buy subscriptions also saw its stock tumble during and since this same period of time
Will this space see more competition and elbowing going forward? Yes. But Netflix too has an advantage in this second phase of the streaming wars.
As of this most recent quarter, Netflix had no short-term debts coming due. It had $8.3 billion in long-term debt. But this is more than covered with current cash reserves and free cash flow. Netflix has an extraordinarily secure balance sheet.
Compare that to AT&T. Post-merger with Time Warner, the company had a whopping $249 billion in debt. Just this week, the company had to reassure investors it was acknowledging this hefty sum and was prepared to pay it down. That’s great for shareholders. But while AT&T is paying that debt down, Netflix will be in position to continue making investments and gains.
Finally, its important to note where the experts expect Netflix’s stock to go from here. The rise past $400 per share was huge… and likely far too much too fast. But with shares trading below $300 once again, it leaves analysts with plenty of good things to say.
The average price target across the industry for Netflix is $398 per share. That’s nearly 40% higher than today’s current price. And this isn’t just some shot in the dark. These same analysts expect earnings to rise to $2.66 per share for 2018, up from $1.25 last year. They also expect to see the company pass the $4 per share of earnings mark next year.
So, it isn’t such a stretch to think that this recent correction might have gone too far in the other direction. Sure, shares looked overbought this summer. But now, they might just be oversold.
That leaves traders with a potential to profit from this recent weakness. Fortunately, there’s a strategy for that.
A Trade For Short Term Bulls
There’s no doubt that Netflix is going to be just fine… at least for the foreseeable future. With the holiday season and out-of-state visitors filling homes across the country, many more will be watching Netflix than any year prior.
But seeing a stock shed more than $100 per share in just six months doesn’t leave one eager to buy it up. Plus, with so much new and untried competition chomping at the bit to take on industry leader Netflix in these streaming wars, doubling down to pick up shares of the company might be a bit risky. After all, it could take a long time for investors to realize Netflix is the industry leader for a reason.
Another way to play this for short term bulls would be to simply buy some call options on Netflix. This lets them take advantage of any growth in the short term, without plopping down the full amount of shares.
But that too comes with plenty of risk. For an at-the-money December Netflix call contract, it costs $13.65 per share or $1,365 per contract. That’s a whole lot of money for a position that could just as easily pay out nothing, resulting in a potential 100% loss in three weeks’ time.
Instead, one strategy we’ve discussed many times that might just be the solution to this high price trade is a bull call spread.
The idea behind such a trade is to take advantage of short-term price increases to the underlying company’s stock, while limiting the amount one puts at risk.
To enter a trade like this, one would buy a call option just like a straight bet. But instead of leaving it there, the trader would also sell a different call option with the same expiration date but with a higher strike price. The amount made from selling the second call would offset the high price of buying the first one.
Here’s how this kind of trade looks:
Source: The Options Industry Council
Let’s look at a specific example.
A Specific Bull Call Spread for NFLX
A short-term bullish Netflix trader could buy a December 21 $285 call for $13.65 per share and sell a December $290 call for $11 for a total cost of $2.65. Since each contract represents 100 shares, that’s an outlay of $265 to enter this trade.
That’s less than the cost of a single share of NFLX and far cheaper than just buying the call by itself. It is also the total amount one would have at risk for the duration of the trade. No matter what NFLX does from here, that $265 is the most the trader could lose.
The potential gain from this trade is found by taking the difference in strike prices ($290 – $285 = $5) and subtracting the amount to enter the trade ($5 – $2.65 = $2.35). That works out to $235 since each contract is worth 100 shares.
To put this in perspective, that $235 would be an 88.7% return on the amount of money at risk for this trade.
Netflix shares would only have to hit $290 per share to hit this mark. That’s a rise of just 1.8% in three full weeks. The company’s stock moves about that much in a single day.
So, the probability of this one hitting is much higher than many other trades.
— The Option Specialist