Netflix: Highest Return Protected Covered Call

A protected covered call or collar search performed using PowerOptions tools, seeking to find the highest returning position for companies with a maximum potential loss of 8% and a stock price in an uptrend, produced digital video content provider Netflix (NFLX) as shown below:

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On the trail of Netflix were software company TIBCO Software (TIBX), mining and natural resources company Cliffs Natural Resources (CLF), application delivery networking company F5 Networks (FFIV) discussed in this article and cyber security company Sourcefire (FIRE).

A protected covered call may be entered by selling a call option against a purchased or existing stock and using some of the proceeds from selling the call option to purchase a protective put option. The Netflix protected covered call has a potential return of 4.2% (33% annualized) and a maximum potential loss of 7.8%, so even if the price of the stock drops to zero the maximum loss is 7.8% (at expiration).

The highest returning positions as shown above were found by selecting to search and sort by the highest returning positions. Stock price for companies in an uptrend were found by selecting to include companies with a 100-day moving average greater than the 200-day moving average. The 8% maximum loss parameter was selected, as a loss of 8% or less can typically be recovered fairly quickly using income generating investment methods.

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Netflix started out as the DVD-by-mail company, but has recenlty supplanted Apple (AAPL) as the leader in the US online movie business. Netflix has also launched its own content deliver network for providing online content. This is slightly bad news for Internet content delivery company Akamai (AKAM) discussed here and here.

In Netflix’s most recent letter to shareholders (pdf) posted on April 23, 2012, the company noted added 3 million streaming members which brings the total to 26 million globally. The company added 1.2 million international customers with the largest growth driver as a result of launching new service in the UK and Ireland. Netflix’s DVD membership declined to 10.1 million and the company had a loss of $5 million or $0.08 per share, but expects to return to profitability in Q2 of 2012.

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Netflix has quite a few competitors including Apple, Amazon (AMZN), Blockbuster (private) and Redbox Automated Retail (private).

Since Netflix’s price change debacle in July of 2011, the company’s stock price has dropped sharply as shown below:

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It looks like Netflix’s stock price is putting in a double bottom, and the company appears to have righted the ship, but an investor or a potential investor, can take advantage of the protected covered listed in the table above to position for generating a profit, yet be protected from a large drop in the stock’s price. The specific call option to sell is the 2012 Jul 65 at $6.65 and the put option to purchase is the 2012 Jul 57.5 at $2.76. A profit/loss graph for one contract of the Netflix protected covered call is shown below:

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If the price of the stock drops below the $57.5 strike price of the put option, the value of the protected covered call remains unchanged (at expiration). If the price of the stock increases to around $75, the position can most likely be rolled in order to realize additional potential return.

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