Netflix earnings are out after the bell Thursday. Here’s why traders may want to use an upside call option as a substitute for a long stock position into results right now. Netflix shares are up more than 35% in the past 12 months ahead of its earnings report, currently placing it about 4% from the average price target of analysts. The key question is whether the company has peaked or has room for further growth. Breaking down Netflix fundamentals Netflix faces much more competition in the streaming industry than it did a few years ago. Historically, there have been several reasons to doubt the company’s prospects. Two primary concerns were the high content costs and the ability to convert subscriber growth into significant profits and free cash flow. These concerns were valid, given that Netflix had accumulated over $10 billion in negative cash flow in the decade leading up to the pandemic through December 2019. The entry of major media and entertainment companies into streaming, especially during the pandemic lockdowns, added to the competitive pressure. Despite these challenges, Netflix has managed to address these issues effectively. The company has tackled content costs by producing its content and has maintained subscriber growth despite the increased competition. This strategy has led to a significant turnaround in the company’s financial performance. Over the four fiscal years from 2020 to 2023, Netflix reported over $10 billion in free cash flow, reversing the negative cash flow of the previous decade. Margins have improved, and top-line growth has accelerated as Netflix has addressed user sharing and introduced advertising. Net income margins, which were just over 9% in FY2019, are projected to exceed 20% in FY2024. However, Netflix’s market penetration is already high, so further operational and business improvements are crucial to justify the company’s current multiple of nearly 32 times forward earnings. The current market volatility, especially among top-performing stocks from the past year, presents a dilemma for investors. Some may be hesitant to invest further due to potential market rotation. Options trading idea A notable institutional trade involved purchasing 200 July $700 calls. These calls, 8% out of the money, traded for $9 each, representing just under 1.4% of the current stock price. The average move for Netflix over the past eight quarters has been around 9.5%, compared to the implied move of 8.3% for this earnings report. If you’re interested in why traders may want to use an upside call option as a substitute for a long stock position, read on. An analysis of similar trades over the past eight quarters shows that such trades were profitable four times and unprofitable four times. Despite the 50/50 success rate, the average return was positive. The maximum loss was the premium spent, but the wins ranged from 1.4% to 3.7%, leading to an overall average trade return of 66 basis points. While this may not seem substantial, it’s important to consider that these were one-day trades around discrete events. Netflix’s operating performance has been strong, but continued growth is essential. If the growth trajectory falters, the stock could face significant pressure. Based on historical multiples, Netflix’s stock price could be about 5% lower than its current level. One valuation metric, Enterprise Value to Earnings Before Interest and Taxes (EBIT), indicates that Netflix is not unreasonably priced relative to its historical performance. NFLX 5Y mountain Netflix, 5 years Additionally, a five-year chart raises concerns about a potential double top, adding another reason to consider options-based stock substitution strategies. DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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