How To Trade The One Tariff-Proof Tech Stock

Netflix NFLX reported earnings last Thursday and the response has been positive among traders. The stock has bounced up, briefly recovering the $1,000 price target and now hovering just below that level.

The broad market remains volatile amid the trade war with China, but based on Monday’s price action, we may have a tradable bottom. However, the topside could be limited in the near term.

That’s the perfect setup for this “back ratio” trade.

Netflix’s relative resistance zone sits right around $1060, while support is well below near $700.

The back ratio call spread involves buying one call option just below that resistance zone. At the same time, selling two calls just above that zone, like so:

• Buy to open 1 NFLX 960 calls 
• Sell to open 2 NFLX 1080 calls 

I’ve picked September expiration dates to ‘jump’ over the volatility we are likely to see in the summer, which remains unknown. The back ratio holds risk but allows us to finance this bullish position into the future. 

This trade requires a margin if the stock is not already in your portfolio. For every call we buy, we sell two calls at higher strikes allowing us to finance part of the position. 

As for cost, the back ratio above holds a current credit of $11.55 at the time of this writing and will define the maximum credit if prices fall below $960 into expiration. 

The breakeven price of the stock at expiration on this trade is $948.45 at this writing, so we will be in profit above this price into expiration. 

The maximum profit for this position is calculated in the following way: the long strike $960 subtracted from the short strike $1080 is $120. This difference times 100 yields $1,200 plus the credit we collected at the trade outset, $1,155 is $1,355. If we do not breach the $1,080 price, we achieve maximum gains for the position. 

If we do not own the stock, we will have a theoretically unlimited risk exposure, as prices could move dramatically, so we must calculate where our returns diminish. Every penny above the stock price of $1,080 reduces our profit. If the stock rises past $1,080, a trade adjustment is advised. 

As with all option plays, there are many ways to leave the trade, but I will discuss the following: 

1. Sell the back ratio when it has accumulated a predefined profit for your trading style. We have time on our side with this kind of trade, so as long as support holds, the trade premise remains valid. Set an alert for $1,080 as there is only risk if the stock rises sharply and stays there. 
2. Sell the back ratio when there are less than 21 days to expiration as volatility expansion will affect these positions significantly. 
3. Sell the back ratio when it hits a predefined stop or risk limit for your trading style. This trade will erode profits the further above $1,080 it climbs. 
4. ** You could turn this into a butterfly by buying the strike at $1200, but this becomes a debit and the risk will now be the outlay of cash to purchase the position.

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