The Tesla derivatives strategy which I described in May is now coming to a successful close. With the broad market selloff that is now underway providing a backdrop of higher volatility, the possibility of establishing a similar position in the August expiry at a higher strike is worth considering.
Last month, I suggested capitalizing on extremely high implied volatility by writing puts against Tesla Motors (TSLA). (See “Extreme Investor Worry in Pre-Earnings Options Pricing: Is Tesla Like Apple?”.) Investors who left that strategy to run its course, rather than closing the short option position and booking profits immediately when Tesla subsequently roared upward on strong earnings, are now looking at the last day of trading for June options and will be booking their profits.
With Tesla having climbed so sharply since May — it is now trading just under $100 per share, versus a little over $57 at the time — many would argue that the risk/reward picture has changed for the worse. Nonetheless, for investors who are still willing to own Tesla anyway, the current broad market selloff and corresponding increase in volatility may make this strategy worth revisiting. With implied volatility of around 73% and an option premium of $9.20, the September 90 strike provides a break even point of $80.80; in other words, selling the September 90 put option will not lose money unless Tesla drops by 20% at September expiry. The maximum profit, on the other hand, should Tesla remain above $90 at September expiry, is $920 per contract, or a little under 32% of the margin requirement of approximately $2900 or so for establishing the position. (In the case of Tesla, the margin requirement is 30%; for selling a put, total margin requirement is therefore 30% of the current stock price, plus the option premium, minus any amount by which it is out-of-the-money.)
Returning to that question of risk/reward, it’s notable that Tesla remains one of the most highly shorted stocks on the market — with nearly 30% of the float short as of the end of May. Such large short interest can provide significant downside cushion, and in my view is almost always a favorable sign for an investor looking to take a long position for independent reasons — i.e., for reasons separate from the short interest itself. And despite the much higher price now, the company’s fundamentals arguably look much stronger than they did just two months ago. However, opening the short option position today is quite a bit different than it was in May, when a large part of the picture was company-specific volatility inflating the option premium. Tesla is still a highly volatile stock, of course, but with the broader market selling off so sharply during the second half of this week, the level of systemic risk will likely be perceived by many investors as significantly higher. The combination of company-specific volatility and broader market gyrations may leave many investors reluctant to establish the type of hedged long position I’ve just described.
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