Following Netflix’s (NASDAQ:NFLX) impressive earnings call last week, the stock witnessed a significant uptick, creating an unfilled gap between 500 and 540. Exploring a distinctive approach to capitalize on this price action, a broken wing butterfly option trade emerges as an intriguing strategy, carving out a profit zone within the range as mentioned earlier.
A broken-wing butterfly with puts is essentially a butterfly spread but with long put strikes positioned unevenly relative to the short put strike. This strategy, often viewed as slightly bullish, involves buying a put, selling two lower puts, and purchasing one further out-of-the-money put. The key is to establish the trade for a net credit, eliminating upside risk.
In the case of NFLX, a potential March 15 expiry broken wing butterfly could involve buying the 480 put, selling two of the 520 puts, and buying the 540 put. As of the latest market close, the trade incurs a net debit of $60, limiting the maximum loss on the upside to $60, representing 2.90% of capital at risk.
The trade’s downside risk is calculated by taking the difference between the widths of the puts (20) multiplied by 100, plus the premium paid, resulting in a maximum loss of $2,060. Conversely, the maximum gain can be calculated as 20 times 100 minus the net debit, yielding $1,940.
This strategy’s optimal scenario envisions NFLX initially remaining flat and gradually drifting lower, ideally closing around 520 at expiration. The primary profit zone spans between 500 and 540. The trade commences with a delta of 1, indicating a slight bullish bias, but this may shift to a negative delta closer to expiry if NFLX remains above 520.
Regarding risk management, a stop loss of 10% of the capital at risk or a breach below 500 is suggested. Visualizing the trade’s performance on a graph reveals that early losses can be mitigated by avoiding a swift drop in the stock price. Monitoring the trade over the next month indicates potential profitability within the range of 510 to 580.
While this strategy provides a unique approach to navigating NFLX’s post-earnings surge, it is crucial to recognize the inherent risks associated with options trading. Investors should exercise caution, conduct thorough due diligence, and consult with a financial advisor before making any investment decisions. Remember, options trading carries risks, and investors may lose 100% of their investment.
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