Options Corner: Netflix Faces Temporary Breather After Statistically Rare Rally

No one is disputing the utter dominance of content streaming giant Netflix Inc NFLX. Since the beginning of this year, NFLX stock has gained about 40%, absolutely clowning the Nasdaq Composite index, which is up less than 1% during the same period. Over the past 52 weeks, the security has nearly doubled in value, again putting on a clinic. Still, bullishness is linear — until it's not.

To be crystal clear, Netflix represents a fundamentally stout enterprise. In April, the company reported first-quarter earnings and it was more of the same — in the best possible sense of the phrase. On the top line, the company generated revenue of $10.54 billion, beating the consensus target of $10.52 billion. Further, it posted adjusted earnings per share of $6.61, exceeding analysts' view of $5.74.

Following the earnings disclosure, several Wall Street experts reiterated their bullish ratings, with most raising their 12-month price targets. In a show of force, NFLX stock has now exceeded these upgraded expectations.

At the same time, it's possible to have too much of a good thing. What investors should be aware of is that currently, NFLX stock is on course to print nine consecutive up weeks. An up week is defined as Friday's closing price being higher than Monday's opening price.

Going back to January 2015, there has only been a single time when NFLX stock has printed nine consecutive up weeks. That lone incident resulted in a reversal, with a one-week loss of 2.64%. Granted, this is a sample size of one so investors shouldn't overreact to the data.

Nevertheless, it's also important to consider the underlying psychology. Netflix doesn't pay a dividend, which makes NFLX stock more susceptible to early investors locking in profits. While very few are adamantly bearish on NFLX, the reality is that 10-year Treasuries offer a risk-free yield of 4.55%. There's no reason for investors to ride out volatility with this kind of alternative safe haven.

Elevated Correction Probabilities Pose Challenges For NFLX Stock

Sample sizes are crucial in statistics, meaning that the above sample size of one requires a huge grain of salt. Still, the practice of streak analysis carries a distinct advantage over traditional methodologies of fundamental and technical analysis: stationarity.

At it core, streaks represent discrete, binary events — investors are looking for streaks of accumulation or distribution, up weeks or down weeks. As a result, streak analysis can be conducted across time because the metric of comparison is static. In colloquial terms, the analysis is speaking the same language.

On the flipside, it's practically impossible to conduct a similar assessment using continuous scalar signals such as stock prices or earnings. These metrics often change dramatically over time and can also shift due to regime changes. As well, administrative factors such as share dilution or buybacks can easily distort the signals, making statistical analysis either overly complex or nonsensical.

Adding to the remarkable win-streak argument for NFLX stock, it should be noted that in the past decade, the security has only witnessed nine occasions where it posted nine up weeks (in any order) across a 10-week period. From a market breadth perspective, NFLX is currently on track to print a "9-1" sequence.

On six occasions (66.67%), the following week's price action results in downside, with a median loss of 2.73%. Assuming that NFLX stock closes at $1,250, the implication is that it's possible the security could temporarily correct to around $1,216.

Interestingly, last week, NFLX stock printed an 8-2-U sequence. Historically, this pattern carries a following week downside risk of 53.57%. Obviously, the implications of this sequence aren't panning out as expected. Nevertheless, as NFLX stacks more accumulative sessions without correction, the statistical risk of temporary downside rises considerably.

A Bold Move For The Agnostic Trader

As a strong and much-loved company, Netflix doesn't have many doubters. However, all healthy rallies eventually encounter a breather. Emotionally agnostic traders that want to attempt to take advantage of this possibility may consider the 1225/1220 bear put spread expiring June 20.

At time of writing, this transaction involves buying the $1,225 put and simultaneously selling the $1,220 put, for a net debit paid of $250. Should NFLX stock fall through the short strike price at expiration, the maximum reward is also $250, a payout of 100%.

Primarily, this trade is tempting because of the statistical argument laid out above. Whether looking at the landscape from a nine-week consecutive win streak or as a 9-1 sequence, the historically observed performance risk sits at a loss between 2.64% and 2.73%. If NFLX stock closes this week at $1,250, the implication is that the security may land somewhere around $1,216 to $1,217. In either case, that's more than enough to trigger the $1,220 short strike price.

As a final cautionary note, Netflix is a fundamentally robust business and any downside will likely be ephemeral. If a substantive correction materializes prior to expiration, traders should consider exiting the spread early. While this would leave time on the clock (and thus a penalty against the payout), NFLX could easily bounce back in a hurry.

In other words, this trade is about skimming profits from the ebb and flow of a high-powered growth stock; it is not about expressing long-term skepticism of an obviously standout performer.

The opinions and views expressed in this content are those of the individual author and do not necessarily reflect the views of Benzinga. Benzinga is not responsible for the accuracy or reliability of any information provided herein. This content is for informational purposes only and should not be misconstrued as investment advice or a recommendation to buy or sell any security. Readers are asked not to rely on the opinions or information herein, and encouraged to do their own due diligence before making investing decisions.

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