Everyone is Selling Netflix, but This Indicator Says It's a Screaming Buy

From time to time, the market hands us a gift, although it's not always easy to recognize.

Netflix (NASDAQ: NFLX) was a thorn in the market's side Thursday, down over 26% in early trading. But the panic selling triggered a buy signal from one of the most dependable technical indicators. In fact, in the past year, this signal has been accurate 100% of the time in NFLX.

The sell-off followed the company's third-quarter earnings announcement. Netflix actually beat analysts' expectations, delivering an 85% year-over-year profit increase to $0.96 per share versus an anticipated $0.93. But it disappointed with its fourth-quarter guidance.

Moreover, subscriber additions of 3.02 million in the third quarter fell short of management's previously announced guidance of 3.69 million. Keep in mind that this metric is simply an estimation the company uses internally and offers to analysts who would otherwise have little to go on.

Unfortunately, that message was conveyed in the conference call following the earnings announcement by Netflix CEO Reed Hastings, who isn't known for his tactful deliveries. (He sent shares plummeting in 2011 after abruptly and nonchalantly announcing the separation of Netflix's DVD and streaming services and raising prices.)

In regard to the subscriber miss, Hastings said: "Remember that what we're providing is our internal forecast and we expect to miss pretty frequently. [The forecasts are] a mid-point... so we'll be a little above that, a little below that every quarter."

I believe his dismissal was not an attempt to dodge a problem, but rather to show that Netflix is still on point. The company displayed remarkable third-quarter earnings growth, and it has added 12.64 million paid streaming customers over the past 12 months.

The bottom line is that the fundamentals are sound and the company is still growing, yet the stock is 20% cheaper today than it was on Wednesday. To me, that's the sound of opportunity knocking. 

More importantly, we are seeing a technical occurrence that has taken place five times in the past year, and each time, it has been profitable.

NFLX Stock Chart

On the chart, I have included the upper and lower Bollinger Bands. Rather than using arbitrary levels to define "overbought" and "oversold," this indicator adapts to a stock's price action.

Think of Bollinger Bands like highway lane markers. When a car veers too far to one side or the other, it's likely to swerve back to remain in its lane. This is also the case with stocks -- when they move too far in one direction or the other, they are likely to revert back within their "normal" trading bounds, marked by the Bollinger Bands.

Looking at Netflix's chart, notice that the lower Band has been pierced five times before this in the past year. In four of those instances, the stock rebounded quickly. The break in late March was followed by more selling thanks to news that Carl Icahn was selling 50% of his stake in the company, but a rebound did follow in April.

And in all five instances, traders who purchased shares on this buy signal would have made a profit. Following each break of the lower Band, NFLX managed to take out the highs preceding it.

Based on this, we would expect NFLX to trade back to the $489 area this time around. But given the current market environment and how far the stock has fallen, I'm placing my price target at $380, which is the high from April 22, following the late March break. This will likely be a resistance area as it coincides with the low of the big rally on Jan. 28.

The $380 target is about 6% above current prices, and I expect it to be hit within a matter of days. Using a call option strategy, we can leverage that move into 33% gains, limit our risk and give ourselves a little more time for the trade to work out.

NFLX Call Option Trade

Today, I am interested in buying NFLX Dec 315 Calls for a limit price of $49.

NFLX Call Option
Risk graph courtesy of tradeMONSTER.

Due to the volatility and the fact that this in an expensive stock, the options are pricey. But keep in mind that buying 100 shares at recent prices would cost roughly $35,700 versus $4,900 for one option contract. This call option has a delta of 80, which means it will move roughly $0.80 for every dollar that NFLX moves.

The trade breaks even at $364 ($315 strike price plus $49 options premium), which is 2% above current prices.

If NFLX hits my upside target of $380, the call options will be worth at least $65. Once you enter the trade, place a good 'til cancelled (GTC) order to sell your calls at that price.

Recommended Trade Setup:

-- Buy NFLX Dec 315 Calls at $49 or less (use limit orders) 
-- Set stop-loss at $25
-- Set initial price target at $65 for a potential 33% gain in two months

If you have a question or comment about today's strategy, please send it to editors@profitabletrading.com.

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