Is this the shape of things to come?
NFLX punshished the shorts in the morning but then proceeded to destroy anyone foolish enough to buy them over that $325 mark the rest of the day. I had mentioned, in the morning post, that NFLX was an example of how the market had become detached from reality – and this is what happens when reality reasserts itself.
We already had some large, short positions in the stock, most recently a March $350/305 bear put spread we had added to our Short-Term Portfolio in our Member Chat on Monday (as well as a still-bearish adjustment in our Long-Term Portfolio), ahead of earnings. As NFLX jumped SO high in the morning yesterday, we added 5 short Nov $400 calls at $11.50 ($5,750) in our Short-Term Portfolio and by the end of the day, NFLX had dropped so hard and fast that we simply bought back those calls for just $1.80 for a very nice $4,850 gain (84%) in 6 hours. At the close, we used our 5% Rule™ to determine:
The prior run was $240 to $320 (33%) but we'd really expect to see action at 40% ($336) and 50% ($360) and – well look at that – that's exactly what we got! $240 to $320 was a "real" move and we expect $16 and $32 pullbacks from there to $304 and $288. So, we know our NFLX supports on the way down should be $324 (short-term weak retrace), $318 (short-term strong retrace) and then, if $318 fails, we'd expect to see $304 (long-term weak retrace) and $288, which is where we'd probably look to go long for a bounce.
We already sold the 2015 $250 puts in our Long-Term Portfolio, putting a value floor on the stock there earlier in the week. In our Long-Term Portfolio, we had 40 short March $340 calls at $50.25, which finished the day at $30.25, up $80,000 (40%) in 2 days as part of a spread, so let's call $350 the top of our expected range for NFLX.
Our cover to that trade is the 2015 $225/230 bull call spread, which threads the needle between $250 and $350 but, this is a trade idea we initiated on July 18th, when NFLX was at $260 into previous earnings. It's called Value Investing – look it up!
Knowing the actual VALUE of a stock helps us make much better decisions as the PRICE of the stock moves around. Yesterday, we KNEW $400 was ridiculous (I had said $320 was ridiculous before earnings and stuck to it after) so we sold premium into the initial excitement, opening our own stock market casino to all the eager gamblers who were willing to pay us $11.50 to bet NFLX would be over $411.50 at November options expiration (23 days, 15th).
The best part of operating a stock market casino – even better than those who run real casinos – is that we can do what we did yesterday which is SHUT DOWN THE CASINO while we were ahead. Why should we, after winning a quick 84% ($4,850) on our day trade, allow our traders to keep gambling and try to win their money back?
All they had left to give us over the next 3 weeks was another $1.80 on that trade but they MIGHT win some or all of the money back if we let them keep playing. So we THROW THEM OUT by buying back the short calls (cancelling the trade) and they leave broke and we move on to the next sucker who thinks he can beat the house.
In other Fundamental news, oil finished out officially on the November contracts at $97.62. The new December contracts (now /CL) fell even further, to $96.43 and that's a pretty serious breakdown if they don't turn up soon. Keep in mind that XOM ($88) and CVX ($121) are both major Dow components and, of course, the energy sector is the second most influential sector in the S&P (behind Financials), so things can get very ugly if oil does begin falling back to $85.
