Netflix May Be About To Drop And Payoff For Shorts

The problem with shorting a momentum play is that you cannot act on fundamentals alone.  We have known for quite some time that Netflix would be under pressure from a competitive standpoint as well as a stock valuation standpoint. Even though these two variables have existed for the past 6 months, we could not enter a short position because of the real threat of momentum. Well, it looks like the action is beginning to move in our direction. Since reaching its high of $209 on December 1st, the stock has had five days in which it has lost $5 or more. These significant downside moves are necessary to flush out the momentum players. We can’t rely on just one or two such moves, it needs to become a trend that occurs even when the market is up. That is all happening. 

Time Warner CEO Jeff Bewkes said the Netflix threat is over and gave a compelling analogy as to why in his NY Times interview, “it’s a little bit like, is the Albanian army going to take over the world? I don’t think so.” To suppose that Netflix won’t face a barrage of streaming competition in 2011 is foolish. Unfortunately for the company, streaming doesn’t count as a barrier to entry. Investors got a little too excited about Netflix as an Apple app play and they also got too excited about the potential for Netflix to become the de facto standard for Internet television. Time Warner is rolling out its TV Everywhere initiative, Comcast is beginning it’s Internet TV service called Spectrum, Google has already launched Google TV, and rumours swirl that Apple will soon offer streaming television and video content through the iTunes cloud. It is quite possible that the day Fortune named Netflix CEO Reed Hastings its CEO of the year was representative of the peak for this company. 

We are ready to tip toe into this short position with plans on feeding it as it generates returns. We will begin with a 2% allocation of NFLX March 2011 $200 puts.  Considering that this stock was at $165 in November, $148 in October, $134 in September, and $101 in August we like the potential of a significant downside move. The Netflix short play we described in our 2011 prediction #8 is beginning to show real potential.  In a rapidly changing tech landscape it’s crucial that investors remain flexible with preference to leadership stocks. 

Jason Schwarz is the author of The Alpha Hunter.

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