Netflix shares have been extremely volatile in recent years, especially around earnings. Goldman Sachs expects the stock to witness similar volatility following the third-quarter of the fiscal year 2015 earnings scheduled for October 14.
Netflix known to be volatile
For the last three quarterly earnings, Netflix’s stock has seen an 18% rally, a 17% growth, and a 19% fall, respectively. Therefore, similar to their recommendation for the 2QFY15 earnings, Goldman Sachs’ Derivative Strategist, John Marshall and Katherine Fogertey are advising investors to go for a “long straddle strategy” i.e. buying call and put options with same strike price and expiration.
Such an approach is useful when investors are sure of a massive movement in the stock, but unsure of the direction of the move. Following the 3QFY15 earnings, Goldman expects Netflix to either rally or drop 17%. The point to note here is that Netflix’s options are priced anticipating a movement of 13.5% after the earnings. This suggests an incongruity in the pricing of options for the streaming firm’s quarterly results.
Not without risks
Even though the approach appears attractive, it is not without risks. If Netflix’s stock fails to fluctuate in either direction by more than $15.65, which is the straddle cost/premium, then investors could suffer a loss based on the number of options traded.
Despite the risks involved, Goldman Sachs has been in favor on such an approach in specific events such as earnings release for big movers like Netflix and Amazon. For Netflix, the analysts note that on an average, the straddle trade has given 48% profit, and the trade has a success rate of 61% since 2010. Such historical trends appeal to the institutional investors, who are always on a look-out for strategies to improve returns during tough trading conditions.
Goldman Sachs has a Buy rating on Netflix with a price target of $135. Of the 45 analysts covering Netflix, 23 rate it a buy, 16 see it as a hold, while the remaining recommend it as a sell. The stock has an average price target of $117.38.
Netflix has been the best performing S&P 500 stock this year. Year to date, the stock is up over 110% while over the last year, it is up almost 61%. At around 10 am EDT Monday, Netflix shares were down 0.43% at $101.82.