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Know How Much NFLX Will Move Post-Earnings? Now You Do!

By Costas Bocelli January 19, 2023 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

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It’s earnings season again, and as usual, prognosticators are coming out of the woodwork to offer their two cents on whether companies will beat or miss expectations for Q4 2022.

Considering the less-than-stellar track record of most financial “gurus” and TV-dwelling talking heads… I’d take most of their predictions with a grain of salt. Or maybe even a tablespoon of salt.

But there is something we do know. And with an uncanny degree of accuracy.

Here’s the Closest Thing to a Crystal Ball

Imagine you had some way of knowing, prior to an earnings announcement, how much a particular stock was likely to  move, UP or DOWN in reaction to that news? 

Well, I’m going to share with you a technique that lets you do just that — to forecast a potentially significant move in a stock’s price in advance of a significant event, such as a quarterly earnings report.

(The beauty of this method is it can be used during the run-up to any major event that investors are focussed on.)

The idea is to try and gauge in advance how big of a move it might make.

The technique involves identifying the price of an options "straddle" on the particular underlying stock.

Don’t be put off by the jargon. A straddle is simply the value of a Call option plus the value of a Put option that both have the same strike price and the same expiration date.

A straddle can be bought or sold. But for this technique, we’re not going to do either.

We’re simply interested in knowing the fair market value (mid-price or "mark") of the straddle.  Meaning what it's trading for in the marketplace.

Now, here’s the thing…

The Straddle is Half the Battle

When using this technique, it’s important to identify the proper straddle.

That's because, in many cases, you’ll find a large menu of options to choose from, so we need to make sure that we target the right ones.

This involves two easy steps:

First, we want to locate the Call option and the corresponding Put option with the strike price nearest to the current market price of the stock. These options are considered to be at-the-money.

Second, we need to pick the proper expiration date.

The closer our expiration date is to the earnings date, the better.

Ideally, you’ll find an expiration date that comes shortly after the earnings event. But what’s very important is that the expiration date captures the earnings catalyst.

The good news is that many widely traded stocks offer weekly options that come with very short expiration periods.

So, it’s easy to find straddles that expire at the end of every trading week.

Now that we’ve located the most appropriate Call and Put options, we simply add the value of the two together (the mid-price between the bid and ask works just fine) and... voila! We just priced the straddle.

More importantly, we’ve just unlocked some very powerful information that could predict the potential move of the stock immediately following the earnings event.

You see, the value of the straddle is the breakeven around the strike price for this particular option strategy.

And since we’ve targeted the at-the-money strike price, it’s basically acting like a hidden breakeven around the current price of the stock.

And because the straddle will expire shortly after the earnings event, that value is essentially pricing in the expected move of the stock.

In other words, we’re able to get a sneak peak of a potential move in the stock based on what the market is implying through the lens of the options market.

This is powerful information!  And quite useful when making investing decisions in the given stock.

And here’s another thing. You didn’t have to trade one single option contract or risk one red cent to obtain this information.

In fact, option pricing on every publicly traded company that lists options is available for free on popular websites such as Yahoo Finance or Google Finance.

Think about it.

By knowing the potential move, you could better locate a level to place a stop-loss order... or place a limit order... or even find a price at which to buy or sell the stock.

For option traders, this information is particularly useful. It helps them decide which strategy might be most appropriate, or helps them choose the strike price(s) when putting the strategy into action.

To get an idea of how effective this technique can be, let’s focus on Netflix (NFLX), one of the most valuable and widely held publicly traded companies in the world with a $145 billion market cap.

Netflix will report quarterly results after the close of trading today (January 19), and management will hold an analyst conference call.

For sure, the stock will be on the move as investors react to the information that will be disseminated. Shares are down 3.06% this week, without any company-specific news (unless you count their advertising for a $385,000 flight attendant position). 

So reaction to quarterly results (good or bad) could really move the needle.

So, where’s NFLX going to trade following earnings?

Before I show you that… let me tell you this. 

This technique is not useful for picking the direction of any potential post-earnings move.

The stock could have a positive reaction and go UP…

Or it could have a negative reaction and trade DOWN…

Heck, it could even just trade sideways.

But what this technique can do is tell you how far – up or down – the marketplace expects the move to be.

In other words, it’s a statistical gauge of a measured move.

And in the case of NFLX, the market expects that, following earnings, the stock will move UP or DOWN by $33 per share.

How do we know this?

We can get this information by pricing the appropriate straddle.

With NFLX trading at $326, we could look to the weekly 325 straddle which expires tomorrow. (Remember, we’re NOT going to actually buy the straddle this time around. We just want to see how the technique works.)

(Click any image to enlarge)

You’d find that the straddle is trading at $33.

Which means the breakeven is 33 points above and 33 points below the 325 strike price.

So, we’re looking at a 66 point range (+/- 10%).

In the event of a positive reaction, you’d focus on $358 per share.

And in the event of a negative reaction, you’d focus on $292 per share.

These are sensitive price points that interested investors will naturally react to, whether they realize it or not.

Now, no financial model is 100% foolproof. But what I’ve found is that straddle breakevens are useful for making better, more informed, investing decisions.

It never hurts to have a little known "floor traders trick" up your sleeve for that.

Got options?  You should!

 Costas

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