NFLX – When the Option Market Is Off The Mark

By now we are all familiar with the movement in Netflix (NFLX) stock yesterday. As I was leaving the house for the brisk walk to the train this morning I was double checking some NFLX numbers for this blog.  When my wife looked over my shoulder to see what I was checking on, even this (very) casual market observer said, “Netflix was a disaster yesterday wasn’t it?”

Now is time for the Monday morning quarterbacking and in my case this means checking out what the option market was expecting as far as a price reaction from NFLX. As a reminder the stock dropped from 118.84 to 77.73 yesterday based on the financial results released by the company yesterday. So what were the options expecting?

With NFLX at 118.84 a pricing mechanism for the expectation of the magnitude of price movement would be the NFLX 120 Straddle (Long Call + Long Put) using the Weeklys that expire this coming Friday. On the market close on Monday, the NFLX 120 Call was priced at 8.60 and the 120 Put was priced at 9.80 for a straddle cost of 18.40. So a trader trying to take advantage of a big price move, but not considering the direction of the price move would have needed the stock to move to 138.40 on the upside or 101.60 to the downside or a move of just over 15%. The actual move was a drop 41.71 or 35%. That drop in price pushed the NFLX 120 Put up to 42.30 which would have resulted in a profit of 23.90 for a straddle buyer.  

This is by no means a suggestion for traders to run out and buy straddles in front of earnings reports. For the most part market efficiency prevails in front of earnings releases. This is just an instance where the market was way off the mark and those that had an opinion that greatly differed from the overall market were able to profit.