Bracing For Impact on Netflix

Netflix NFLX has crushed many short sellers, among them Tilson Whitney, who publicly published his reason for shorting Netflix, and then rebutted publicly by Netflix's CEO, Reed Hastings. There is no doubt that Netflix is a well-run company, and has executed its strategy flawlessly, turning its stock from less than $20/share in Oct '08, to over $200/share currently, yielding a 10x return for its shareholders in a very short time frame. Spotting a forward P/E ratio > 35, Netflix growth engine is its streaming service, where subscribers pay $7.99/month and get streaming of TV episodes and movies to the subscribers' TVs, computers, game consoles, or smart phones. With more and more people spending their time online, this subscription model has proved to be very popular. Without bandwidth metering from carriers, this model also proves to be a profitable one for Netflix. Nonetheless, whatever the reasons are for shorting Netflix, they are still out there, as Whitney Tilson had given a good account of them. For shorting, however, there needs to be a trigger. With the announcement from Amazon.com AMZN offering free streaming for its Prime Service customers, who paid $79/year to get unlimited free 2-day shipping for eligible orders, the time may have come for Netflix to have some real competition. This is also likely to be the first threatening competition for Netflix on streaming service, with more to come from companies like Walmart WMT, Costco COST, etc. who can use streaming service to lure customers into buying or subscribing their products/services. To bet on Netflix's downside, while it's tempting to just short the stock, it is still a risky business given the danger of a short squeeze because of the large outstanding short positions on Netflix. To limit the risk, it's better to use options. In this case, we believe a bear-call-spread probably makes the most sense, as Netflix's price will likely be under pressure in the near-term because of the Amazon.com announcement (not to mention the possibility of an overall market correction because of unrest in the Middle East). A straight put buying or a bear-put-spread can also make sense if the investor has the stomach for it. Daniel Ho is the founder of 10xreturn.com, a financial portal providing financial information and market statistics for investment professionals.