Netflix (NFLX) stock is struggling to break above 500 and is currently below the 50- and 200-day moving averages.
Today, I want to look at a strategy with very low risk on the upside and a healthy profit zone on the downside.
The strategy is called a broken wing butterfly, and we’ll use puts because the strikes will all be out-of-the-money. This helps to reduce assignment risk.
With a regular butterfly option trade, the wings are placed an equal distance from the short strike, but with a broken wing butterfly we leave a larger gap on a particular side. This results in less risk on one side and more risk on the opposite side.
Netflix Stock Broken Wing Butterfly
Let’s take a look at how a broken wing butterfly trade might be set up on Netflix stock.
- Buy 1 June 18 475 put at 6.25
- Sell 2 June 18 450 put at 2.60
- Buy 1 June 18 400 put at 0.85
Notice that the upper strike put is 25 points away from the middle put and the lower put is 50 points away. This broken wing butterfly trade will cost $190 to open, and this is the maximum risk on the upside.
The worst that can happen is all the puts expire worthless and the trade loses the $190 premium.
On the downside, the maximum loss can be calculated by taking the width between the first two strikes (25) multiplied by 100 and adding the premium paid (190).
That gives us 25 x 100 + 190 = $2,690.
The maximum gain can be calculated as 25 x 100 – 190 = $2,310
The ideal scenario for the trade is that Netflix stock stays flat initially and then slowly drifts lower to close around 450 at expiration. The total profit zone is between 427 and 472.
Trade For Those With Bearish Outlook On Netflix Stock
Because the trade starts with delta of -7, this strategy would not be appropriate for bullish traders. The initial exposure is roughly equivalent to being short seven shares of NFLX stock.
For those with a slightly bearish outlook, a broken wing butterfly could be a nice way to trade Netflix stock.
In terms of risk management, I would set a stop loss of 20% of the capital at risk (0.2 x $2,690 = $538), or if Netflix broke below 425.
It’s important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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