Why the risk/reward didn't align for a NFLX straddle
Our traders are stalking a lot of different stocks throughout the week, but not every potential trade idea develops into a formal recommendation to our subscribers. Whether it's the break of a key technical level for the shares, an unexpected news announcement, or an unfavorable options pricing environment, this regular feature will shed some light on the factors we view as "deal breakers" to otherwise intriguing trade setups. Today, Schaeffer's Senior Trading Analyst Bryan Sapp chimed in on one stock he was recently toying with -- but ultimately rejected -- for a long straddle options strategy: streaming content titan
Netflix, Inc. (NASDAQ:NFLX).
What Is a Straddle?
Before we begin, let's break down the long straddle options strategy. A
long straddle is a two-legged approach that allows traders to take advantage of heightened volatility. By purchasing both a call and put option at the same strike price, options traders can profit from a big swing in either direction. The straddle is employed in Schaeffer's
Volatility Trader service, and offers speculators limited risk and theoretically unlimited profit potential.
What He Liked About a NFLX Straddle
Specifically, NFLX shares caught Sapp's eye because:
- There's been a tight consolidation/flag pattern post-earnings. And NFLX Bollinger Bands are pinched, which can often precede a big swing.
- NFLX options are priced as cheaply as they've been all year.
- Netflix is a volatile name. The stock frequently makes big moves, and needs only about a 3.5% directional move for weekly 3/24 options to break even.
- NFLX has relatively elevated short interest. At the stock's average daily volume, it would take more than four days to buy back these bearish bets -- potential fuel for a short squeeze.
Why He Backed Out of a Volatility Trade
However, there were three reasons Sapp ultimately chose not to recommend NFLX straddles:
- Despite takeover rumors on March 3, and an upgrade on March 6, NFLX remained stuck in a range. This could be a sign the stock will remain rangebound for an extended period.
- There are no catalysts in the near future. "I generally like to see some sort of relevant event that could move the stock/ETF -- earnings, shareholder meetings, conference presentations, macro data for macro ETFs, and so on," Sapp said.
- "I won't take a straddle trade unless there's a good probability that it can double," Sapp explained. The straddle Sapp was considering was asked about $4.50, so that would require about a $9 move to double. "NFLX would have to make new all-time highs or break through the Jan. 18 gap to the downside to do so. And there's a high probability that a move up would stall near $145, and likewise a move down to $134 would lead to at least a short-term bounce."
