Trade Review: Netflix Short Vertical Put Spread

02/16/2011 1:00 am EST

Focus: OPTIONS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Netflix Inc. (NFLX) shares have soared more than 6% following a pair of positive reports. First, Caris & Co. lifted its price target to $316 per share from $224. Then, Nielsen Holdings NV (NLSN) announced that Netflix has become the only paid video service company to appear in its top ten list of video services on the Internet. As a result, NFLX has pushed even further into all-time high territory, and was last seen trading just above the $245 level.

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Naturally, options traders have taken a keen interest in NFLX. In fact, near-term put volume has swelled to some 43,000 contracts, or more than double the stock's average daily put volume, while near-term call activity has spiked to more than 54,000 contracts, or roughly triple the daily average. The most active call on the session is the out-of-the-money February 250 strike, with more than 10,500 contracts crossing the tape. On the put side, the out-of-the-money February 235 strike is most popular, sporting volume of roughly 8,200 contracts.

Taking a closer look at NFLX's put volume, it appears that one speculative trader has decided to join the bullish bandwagon by putting a positive spin on a put spread. Specifically, a block of 112 NFLX February 235 puts traded at the bid price of $1.80, or $180 per contract, on the Nasdaq OMX PHLX (PHLX) at about 12:12 pm. At the same time, a block of 112 NFLX February 230 puts crossed on the PHLX for the ask price of $1.08, or $108 per contract. Given this data, it would appear that we are looking at a short vertical put spread, more commonly known as a credit spread, on Netflix. This options strategy is also known as a short put spread, or a bull put spread.

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The trade breaks down like this: The trader pays $12,096 [($1.08 x 100) x 112] for 112 February 230 puts. Meanwhile, the trader receives a credit of $20,160 [($1.80 x 100) x 112] for selling 112 February 235 puts. As a result, the trader has pocketed a net credit of $8,064 ($20,160 - $12,096). The breakdown for this credit spread is listed below:

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Breakeven for this trade is equal to the sold strike minus the credit received, or $234.28 ($235 - $0.72). The maximum gain is equal to the total premium received ($8,064), while the maximum loss is limited to the difference between the February 235 put and February 230 put, minus the net credit received, and is reached if NFLX trades at or below the purchased February 230 strike. In this case, the maximum loss is $4.28, or $428 per pair of contracts [(235 - 230) - $0.72]. Below is a chart for a visual representation:

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Implied Volatility

After the short vertical put spread has been established, increasing implied volatility is neutral to the overall position, as it lifts the value of both the sold option and the purchased option. At the time of the trade, implied volatility for the February 230 put arrived at 53.56%, while the implied volatility for the February 235 put rested at 50.55%. NFLX's one-month historical volatility was 56.64% as of the close of trading on Friday, and these options have less than one week left until expiration.

By Joseph Hargett, contributor, Schaeffer’s Trading Floor Blog

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