A high-probability trade on Netflix as market anticipates a wild move post-earnings

Published Tue, Jan 23 202410:48 AM ESTUpdated Tue, Jan 23 202411:02 AM EST

Nishant Pant @TheMeanTrader @TheMeanTrader

Netflix (NFLX) kicks-off the tech earnings season Tuesday after the close and the market as usual is anticipating a big price movement. We'll discuss a high probability bet that wins if Netflix moves by less than the market anticipates...in either direction. While the impact of earnings announcements on stock prices is acknowledged, predicting the direction of the movement remains elusive. Examining the historical price movements post the last five earnings events in NFLX reveals a trend. Notably, most earnings-related shifts are typically confined within a 10% range. However, outliers like the 13% move on Oct. 19, 2022 and the 16% move on Oct. 19, 2023 underscore the stock's inherent volatility. Any surprise beats or misses in subscriber numbers have the potential to trigger substantial movements. Considering seasonality, the price movement after earnings in January of the previous year was recorded at 8.5%. This historical context provides insights into the potential magnitude of market reactions following the upcoming earnings announcement. As traders speculate on an imminent event, such as earnings announcements, the demand for options rises, leading to an increase in the prices of options expiring shortly after the event. The additional cost, often referred to as "juice" or "premium," is termed implied volatility (IV). In the case of highly liquid stocks, IV (implied volatility) becomes a key metric. It is utilized to estimate the extent to which the options market anticipates the stock's movement following an earnings disclosure. In the provided example, the expected move for NFLX is indicated as $38 in either direction. Once earnings are announced the IV (implied volatility) of the options declines forcefully. This is instantly reflected in options pricing on the following day after earnings, and options lose all this inflated juice thereby dropping drastically in value. An earnings iron condor Selling an iron condor is an options trading strategy where you simultaneously sell out-of-the-money call spreads and put spreads. Since you are selling spreads (instead of selling naked calls and puts, your risk and reward are both defined at the time of entry). To construct this trade, all I need to do is figure out two things: Which strikes to choose to sell the call spread? Which strikes to choose to sell the put spread? NFLX 6M mountain Netflix 6 months To construct the put spread that I will be selling, here is what I need to do: $485 (current price) – $38 (expected move) is $447. This means that NFLX is not expected to drop below $447. To add some more buffer to this, I could sell a $435 put option and buy a $420 put option at the same time (thereby constructing my put spread side of the trade). For the call spread side of the equation, I need to do something similar: Again, the option chain shows that $485 (current price) + $38 (expected move) is $523. This means that NFLX is not expected to pop above $523. We could add some more buffer to this and sell a $535 call option and buy a 540 call option simultaneously. This wraps up the call side of the equation. Trade Structure and Analysis: SELL -1 NFLX 535-540 C/435-430 P Iron Condor CREDIT (also max profit): $140 MAX LOSS: $360 Trade Execution: These post-earnings trades are quick. Traders put them on 1 to 2 hours before the market close on the day earnings are about to be announced. This maximizes the premium one will capture on the trade. You may notice that the premium you are receiving goes up the longer you wait to put on this trade. Note that the put side has a 88% probability of success and the call side has approximately 80% probability of success. Those are very good odds. However, as is the nature of high probability trading, the risk is higher than the max profit. So, we need to have clearly defined risk/reward targets for this trade. Since these trades are high probability trades, I can expect 8 out of every 10 trades to become winners and the winners add up quickly. If the post earnings move is larger than the expected move (and this does happen every now and then), you will usually see the stock in question give up some of its post earnings gap in the first hour of market open. This would be time I would want to get out of the trade instead of letting it go to full loss. Since the losers are only 2 out of 10 (assuming 80% win rate), one could close the losers at 60% - 70% loss and still come out as a winner once they take enough trades for the probabilities to work out in your favor. -Nishant Pant Founder: https://tradingextremes.com Author: Mean Reversion Trading Youtube, Twitter: @TheMeanTrader DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . 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