A disclaimer: what you are about to read is not investment advice. Not even close.
After months of watching Netflix (NFLX) with awe and wonder, I finally broke down and placed a trade. Netflix is an enigma, a stock darling and a dream. A few weeks ago the stock was up more than 100% for the year. Sweet.
I don’t own any shares of Netflix (maybe some of my ETF’s do – I don’t know) but I have been unable to pull the trigger. I have fixated on it and just cannot let it go. Will it continue to soar like an eagle or will it drop like rock?
But I want in…
So, I analyze and find myself stuck in analysis paralysis.
My thought process is something like this (warning you are about to enter my brain – scary):
I am a customer. I subscribe to Netflix. I like it and it is a great alternative to cable. I like their original content too. When I first subscribed, I would binge watched all day and night. Lately though, I have felt less in love. The novelty has worn off. There is still nothing to watch. I have even thought about cancelling my subscription. My parents just cancelled their subscription. Now we are only two customers out of millions but do I want to invest in a company I have thinking about breaking up with?
But look at that P/E ratio? (Trading at a price 200+ times earnings when I am writing this) It means investors think it is going to moon or they are crazy. Sometimes the stock market is crazy. Sometimes, investors cannot see the downside.
And, competitors are coming out of the woodwork. My cable company called and said they would give me their streaming service for “free” if I signed up for a cable package.
But, they say Netflix is going to conquer China. If that is true, then it is undervalued. Doing business (especially media) is easy in China. Right?
And, the stock market is choking on the fumes of its own exhaust and the Fed. The rest of the year is going to be more fun to watch than a Netflix original series.
What to do? What to do?
After much rumination, I decided what to do. I would straddle.
A very small, long options straddle.
I bought one call option and one put option at the same $100 strike price. This is called a long straddle – but I prefer to call it the “bipolar.”
- The call option gives me the right to buy 100 shares at $100, sometime before it expires in January.
- The put option gives the right to sell 100 shares at $100, sometime before it expires in January.
One contract gives you “control” of 100 shares . Those 100 shares have a market value of almost $10,000. Small potatoes in the options world – but big enough for me.
Basically, four things can happen with these contracts:
I can sell one or both of the contracts.
The price of the options will continue to change in response to the market price of the stock. If the Netflix stock price rises, the call will increase in value and the put will decrease. If the price of Netflix falls, the put will become more valuable and the price of the call will also fall. The price needs to swing, like me on a chandelier. A lot.
I can exercise them to buy and/or sell the stock.
If I decide that I want to own the shares I could exercise my call and the investor that sold me the call contract needs to deliver 100 shares to me at the agreed price of $100 each. They could have to hand over 100 shares from their portfolio or they could buy them in the open market and send ’em over.
If I exercise the put, I would have to sell 100 shares. If I happen to own 100 shares at the time, then this is pretty straight forward. If I don’t own any then my broker will loan me 100 to sell and I will be “short” and have to buy them back at some point in the future.
Clear as mud?
The contracts can expire.
These contracts expire in January. If I do nothing before the expiry date they will expire worthless. In this scenario, I will lose all the money I used to purchase them. Every penny. That is going to hurt.
These contracts were expensive. The options with a price premium, over an above their obvious market value. This premium decays over time and the more volatile a stock is or bipolar the market happens to be – the higher the premium. Buh-bye premium.
I could do combinations of the above. Exercise one contract, let the other expire. Sell one and exercise the other. Or if I am feeling wild and crazy I could try to pull of some other strategy, swapping the options (and more money) for other options that expire further in the future or at different prices. The game could go on forever – or until the money runs out.
Why on earth would a person do this?
That is a good question.
- I want to participate.
- I believe that Netflix will experience significant price swings over the next 4 months.
- I don’t want to tie up gobs on money to buy or sell the stock.
- I can’t decide if it will go up or down or if it is overvalued or undervalued.
- I am speculating with risk capital. You may remember those puts I bought…
- I am crazy?
So, feel free to come back in January and we can have a good laugh. I may have just embarrassed myself in front of the entire internet.