Tuesday, November 26, 2013

Netflix (NFLX) - This Newly Minted Giant Has a Big Secret; But It's in the Option Market...

NFLX closed Tuesday trading at $355.20, up 1.4% small with IV30™ down another 3.3%. The Symbol Summary is included below.

Provided by Livevol

Netflix, Inc. (Netflix) is an Internet subscription service streaming television shows and movies. The Company’s subscribers can watch unlimited television shows and movies streamed over the Internet to their televisions, computers and mobile devices, and in the United States, subscribers can also receive digital versatile discs (DVDs) delivered to their homes.

I have written extensively, perhaps to the point of compulsion about NFLX.  You can read any of the prior posts below by clicking on the titles.

This is a volatility note.  The first time I note low volatility in NFLX it was trading $216 at 46% vol.  Today it is $355 at 35% vol.

10-15-2013: Netflix (NFLX) - How a New Industry Giant Shows 'Cheap' (?) Volatility into Earnings; Did You Know This?

9-18-2013: Netflix (NFLX) - The New Giant -- Stock Near All-time High but Volatility Collapses to Multi-year Low

9-10-2013: Netflix (NFLX) - Is this the Most Powerful Firm in Entertainment? Some Things I Bet You Didn't Know... But Want to.

4-25-2013: Netflix (NFLX) - Vol Nears Multi-Year Lows as Stock Explodes; Hollywood Take Note -- Another Shot Across Major Distributor’s Bows

Here is a quick review from the most recent posts, which is relevant to this note which surrounds substantially depressed volatility in the option market.

So why is this happening to NFLX? Well, a lot of reasons, but one of the biggest is pretty simple:

NFLX now decides which TV shows are hits. Yeah, that's right. For example, the AMC original show Breaking Bad, the highest rated TV show ever by meta critics, was at a point after season 4 where its record viewership for any one episode was ~1.5 million people. That's actually very low. CBS has nights where shows hit 20 million. The Walking Dead (also on AMC) hit over 12 million. So, Breaking Bad, though a bonanza on the critical side, was actually kind of a poor performer in terms of viewership. Then NFLX happened.

An agreement was struck to put all of the "Breaking Bad" old seasons on NFLX for free (everything is free on NFLX with the monthly subscription). The first episode of season 5 aired to 3 million viewers (so a 100% increase). Then, the first episode of season 5 part II aired to 6 million viewers (NB: My numbers may be off wrt which season the bump(s) happened, do some fact checking before quoting me). OK, OK, is this really b/c of NFLX? Well, here's a direct quote from the show's creator, Vince Gilligan:
"I am grateful as hell for binge-watching. I am grateful that AMC and Sony took a gamble on us in the first place to put us on the air. But I'm just as grateful for an entirely different company that I have no stake in whatsoever: Netflix. I don't think you'd be sitting here interviewing me if it weren't for Netflix. In its third season, Breaking Bad got this amazing nitrous-oxide boost of energy and general public awareness because of Netflix."

Why does this matter? How about this... Instead of NFLX paying for content, the content providers may pay NFLX to air their shows. That's incredible.

Add to the fact that NFLX now has critically acclaimed original content -- that's content available ONLY on NFLX ("House of Cards" and "Orange is the New Black" are two of them) and what we're slowly finding here is that NFLX may become the most powerful content distributor for TV (the profitable part of the entertainment business) on the planet.

Don't laugh or roll eyes, it's happening right now. FOX is tying the same game as AMC did with "Breaking Bad" with their sitcom "The New Girl." And you know what?... it's working again...

Now NFLX does have competitors, namely AMZN (I know they're not the first name to come up from entertainment industry folks, but the entertainment industry is wrong -- AMZN is the risk for NFLX). Another risk is the content creators using their own channels (no pun intended)... but that doesn't seem to work so far (and yeah I know what Hulu is and who created it).

Here's more news, from CNBC a day after I posted this article:
Groundbreaking news that Virgin Media is bringing Netflix directly to its set-top box in the U.K. in effect elevates Netflix to the status of a new cable network-a benefit for a cable company and beyond being an upstart threat to cable.

The deal, which makes Netflix available on cable set-top boxes for the first time, was announced Monday. On Tuesday, Netflix shares hit a new all-time high, trading 6.5 percent higher to $313, flying past its record $304 on July 13, 2011.

The stock's nearly 220 percent gains this year have been driven largely by the success of its original content deals, which have helped add new subscribers, giving Wall Street confidence that exclusive originals will continue to deliver.

(More from Julia Boorstin: Is Apple's iRadio a Pandora killer? )

Virgin's parent, Liberty Global (LBTYA), gained just under a percentage point on Tuesday's news.

Virgin Media's partnership with Netflix is the first time a cable operator is bringing the streaming service directly to the set-top box. Other cable operators-like Comcast (CMCSA)-allow users to access Netflix through Internet-connected set-top boxes-but this is the first time a cable channel has directly made a deal with Netflix to treat its content just like that provided by cable channels like HBO (owned by Time Warner (TWX)) and Showtime (owned by CBS (CBS)). (Disclosure: Comcast is the owner of NBCUniversal, the parent company of CNBC and CNBC.com.)

Virgin will integrate Netflix with its television content so it's easy to seamlessly browse and search across both TV and streaming content.

Source: CNBC via Yahoo! Finance Why Netflix is at a new all-time high, written by Julia Boorstin.

On 10-15-2013 I noted that the volatility into earnings for NFLX was quite low.  The stock did in fact go from ~$355 to~$322 in a single day (while in that same day hitting $389, then dropping $65 intra-day).  But since then, well, we're back to $355.

The two-year Charts Tab is included below.  The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

Provided by Livevol

So the stock is up huge,the importance of this firm in the industry is up huger and the valuation proves it.  We're talking about a $21 billion firm now.

But here's the the thing, and there's no way around it.  The higher NFLX stock goes and the more power it has in the industry, the greater the potential fall.  I am a huge fan of NFLX and their management team's ability to resurrect a firm that many thought was dead (or on its death bed, at least) to an incredibly powerful "new" firm. But, at these valuations, there is risk.  Also, there is substantial risk of higher valuations.  While $21 billion is a big firm, why can't NFLX be worth $100 billion?  So, I say, there is risk to both sides in this stock, yet the option market tells me I am wrong... and here's why...

Let's turn to the two-year IV30™ chart below, in isolation.

Provided by Livevol

What we see, quite plainly, is that NFLX volatility has dropped to a multi-year low.  I have drawn that yellow horizontal line back two-years to illustrate the level of the current implied.  So a few mitigating factors:

1. The market wants to go up right now, it just does... So volatility (VIX) is low.
2. We're heading into Thanksgiving; a sleepy time not just for our grumbling tummies but also for the market at large.

But here's the fact that takes that mitigating factor stuff and throws it out the window.  Jan' 14 volatility is almost equally as depressed.  Yeah... it's true...

Finally, let's turn to the Options Tab, for completeness.

Provided by Livevol

So we know Dec vol is low per the IV30™ -- it's priced to 34.25% per the top of the Options Tab (the green numbers).  But... Jan'14 volatility is priced to 36.49%, and that ain't much higher.  Is tat volatility fairly priced for NFLX? I dunno... But it ain't high...right?...

This is trade analysis, not a recommendation.

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