NFLX Overbought? Consider Bearish Put Spread for Potential Pullback

Investment Analysis & Recommendation

Asset Monitored: Netflix (NFLX)

Key Observations from Discussion:

• Stock Code: NFLX
• Significant Price Action: NFLX has seen a notable 16% jump from its previous high and has been on an upward trend for nearly a month.
• Technical Indicator: The Relative Strength Index (RSI) has been above 70 for a while, which often suggests the stock is overbought.
• Sentiment (Original Poster): Short-term bearish, expecting a price correction or pullback.
• Proposed Strategy: Bear Put Spread.
• Discussion Volume: Currently low, with some interest in further opinions.

Analysis of Investment Opportunity:

The original poster points out that Netflix (NFLX) has had a significant price increase, with the RSI staying above 70 for a while, indicating an overbought condition. They suggest a put spread, a defined-risk options strategy, to potentially profit from an anticipated short-term price correction. This bearish approach is for traders who think NFLX might be due for a pullback after its strong rally.

An overbought RSI, especially for an extended period, along with a sharp price run-up, can indeed suggest that a stock might be ready for consolidation or a pullback. However, it's important to remember that "overbought" doesn't always mean an immediate drop; stocks can remain overbought for quite some time in strong uptrends.

Investment Advice & Proposed Plan:

The proposed Bear Put Spread on NFLX is a valid strategy for expressing a bearish short-to-medium-term view while managing risk. Here’s a breakdown and some considerations:

1. Strategy: Bear Put Spread

• Mechanics: This involves buying a put option at a specific strike price (Long Put) and simultaneously selling another put option with the same expiration date but at a lower strike price (Short Put).
• Cost: The net cost is the premium paid for the long put minus the premium received for the short put (a net debit).
• Maximum Profit: Achieved if NFLX closes at or below the short put's strike price at expiration. Max Profit = (Strike Price of Long Put - Strike Price of Short Put) - Net Debit Paid.
• Maximum Loss: Limited to the net debit paid for the spread. This occurs if NFLX closes at or above the long put's strike price at expiration.
• Goal: To profit from a moderate decline in NFLX's price.

2. Investment Plan Considerations:

• Confirmation: While an RSI above 70 is a warning, it’s wise to wait for additional confirmation signals before entering a bearish trade. This could include:
  • RSI divergence (price makes a new high, but RSI makes a lower high).
  • RSI crossing back below 70.
  • A break of a short-term support level or trendline.
  • Bearish candlestick patterns.
• Strike Selection:
  • Long Put (Buy): Consider buying a put that is At-The-Money (ATM) or slightly Out-of-The-Money (OTM). An ATM put will have a higher delta (sensitivity to price change) but will be more expensive.
  • Short Put (Sell): The strike price of the short put will determine your maximum profit potential and help reduce the overall cost of the spread. The further OTM this put is, the lower the premium received, but the wider the potential profit zone.
  • Spread Width: The difference between the long and short put strikes. A wider spread offers higher potential profit but also costs more (higher max loss).
• Expiration Date:
  • Choose an expiration date that allows sufficient time for the anticipated pullback to occur (e.g., 30-60 days).
  • Be mindful of time decay (theta), which erodes the value of options as expiration approaches. Theta works against the buyer of a net debit spread.
• Implied Volatility (IV):
  • Ideally, enter a debit spread when IV is relatively low and expected to rise, as this can increase the value of the options. However, for a stock that has run up significantly, IV might already be elevated. If IV crushes after entry, it can negatively impact the spread's value even if the price moves favorably.
• Position Sizing:
  • Only allocate a small percentage of your trading capital to any single options trade. The maximum loss is defined, but it should still be an amount you are comfortable losing.
• Catalysts:
  • Be aware of any upcoming earnings announcements, news events, or overall market shifts that could significantly impact NFLX's price, potentially overriding technical signals.
• Profit Target & Stop-Loss:
  • While the max loss is defined, you might consider exiting the trade if it moves against you by a certain percentage before reaching max loss.
  • Define a profit target (e.g., 50% of max profit potential) at which to take profits, as achieving maximum profit requires the stock to be below the short strike at expiration.

3. Risk Management:

• The primary advantage of a put spread is its defined risk. You cannot lose more than the initial debit paid.
• This is a counter-trend strategy if NFLX is in a strong uptrend. Counter-trend trades statistically have a lower probability of success than trading with the trend.
• Timing is critical and difficult. Overbought conditions can persist longer than anticipated.

Recommendation:

A Bear Put Spread on NFLX, as suggested, is a reasonable strategy for traders anticipating a short-term pullback, given the overbought RSI and recent strong price appreciation. However, traders should:

1. Conduct Further Due Diligence: Analyze NFLX's chart for further bearish confirmation signals beyond just the RSI.
2. Assess Implied Volatility: Understand the current IV environment for NFLX options.
3. Carefully Select Strikes and Expiration: Balance the cost, probability of profit, and time frame.
4. Employ Strict Risk Management: Only risk capital you can afford to lose.

This strategy is suitable for traders with experience in options who understand the risks and mechanics involved. It offers a leveraged, risk-defined way to speculate on a potential downturn in NFLX.

Disclaimer: This analysis is for informational purposes only and does not constitute financial advice. All investments carry risks, including the potential loss of principal. Consult with a qualified financial advisor before making any investment decisions.