Earnings and expected movements
Netflix Inc. (NASDAQ: NFLX) is the first of the FAANG shares to report Q1 earnings, with the announcement coming to light today (Tuesday, April 20). Weekly options cost an expected move of nearly 6% in the share through the event.
With the stock moving near $ 555, that means a potential upward move to the everyday highs of around $ 586 (from January) and a potential downward move to around $ 523, which will erode all April gains.
Either an investor agrees with the bullish or bearish consensus, or simply thinks that the options market is pricing the move way too high, because he knows that the expected move could be a useful gut check before any major catalyst event.
Below we will further explore how the expected move can be used by option traders themselves. Especially to help guide the choice of strikes in strategies that want to lower the price of stocks with a higher price during a high volatility.
Alternatives to stock (or calls)
At the time of writing, buying 100 shares would cost more than $ 55,000. Buying a weekly call ($ 235) for $ 235 (for the money) costs about $ 18, or $ 1800 in premium. To make the call profitable on Friday’s expiration, the stock must be above $ 573.
Let us now take a scenario where a trader generally agrees with the 6% expected move and uses the move to pick the strike when creating a defined spread of risk options.
Use the Options AI platform, we look below at some alternative strategies generated with the expected move leading to the choice of a strike.
The debit spread reduction reduces the cost of buying the call-for-the-money purchase by simultaneously selling a call at the expected move level. This in turn brings the break-even level down to around $ 566, while increasing the probability of profit and making extra gains possible if the stock goes to $ 585. The trader also reduced their overall exposure to increased volatility in the options versus a direct call. Less capital is at stake, and a smaller move is needed to at least break even.
Apart from the additional potential risks of option spreads (such as early allocation and liquidity), it is important to note that a spread limits potential gains (if the stock moves beyond $ 585). One way to look at this is that the trader has joined the options market consensus with a view that the stock is less likely to move more than 6% and is therefore willing to limit profits.
The Credit Put Spread is another strategy to express a clumsy sentiment, but on the other hand, it can be seen as ‘selling to cattle’ rather than joining the bulls. Essentially reflecting the setup for a debit spread, a trader may be able to sell a put option on the money while at the same time buying a lower strike on the expected move level. In this case, the trader has completely removed their exposure to increased volatility in the case through a net credit and a break-even point below where the stock trades.
Alternatives to Puts
If a trader is interested in the position for a move lower in the stock, the bearish consensus may serve as a guideline. Again, using the Options AI platform, with the expiration of April 23:
Barriers with a price target
Options AI can also trade based on a user’s price target. In this example, we assume that a trader is a long-time shareholder of Netflix and wants to protect against an extraordinary move to the downside. A price target is placed with 12% in the stock, which expects twice the move options (although any target can be used):
The debit distribution of 530/490 is merely an example. It costs about $ 700, but will protect stocks from about $ 523 to $ 490. In this case, the trader used a target to hedge against a scenario in which the options market is misunderstood.
Options AI offers some free tools, such as an expected calculator, as well as an earnings calendar with expected moves. More information on expected moves and spread trading can be found at Learn / Options AI.
Image by Andrés Rodríguez of Pixabay
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