Netflix will report second quarter earnings after the bell on Monday, but traders are getting pretty excited ahead of time. The stock was up over 5 percent ahead of the announcement on Monday, and options traders are betting that the stock will trade even higher after the release.
In the biggest trade of the day, one trade bought 422 180-strike calls expiring this Friday, for an average price of $9.08. This is a bullish bet that will make money if Netflix is trading above $189.08 by this Friday's close.
The key to trading earnings announcements with options is to understand how expensive options prices are relative to a stock's actual movement. A quick way to check on this is to look at the nearest expiring at-the-money straddle. Buying a straddle would mean buying the at-the-money put and call.
Right now, the 170-strike straddle expiring on Friday is trading for $26, which means that traders are expecting that the stock will be within 15 percent of $170 at expiration. Most of this move is likely to occur Tuesday in reaction to Monday evening's announcement, so we can look at Netflix's historical moves after earnings in order to decide if this volatility is cheap or expensive. In this case, it looks to be on the cheap side—the historical average earnings move is 20.5 percent, and the median is 18.0 percent.
Given that options prices appear to be suggested a muted move on earnings, this trader is betting on a big move, and specifically, a big move higher by purchasing calls.
And why not? In the past, Netflix has reported upside surprises 73 percent of the time, so historically speaking, this has been the winning trade.
—Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."