When investor worry in the run-up to a quarterly earnings announcement pushes implied volatility well above historical levels, naked put writing provides an opportunity to profit from the inevitable fall in implied volatility after results are in.
With Tesla Motors (TSLA) set to report earnings after the close on Wednesday, the stock is currently trading around $57.23. Due to implied volatility over 80%, the June put option at the 57.50 strike is now at a $6.60 bid, while the 55 strike is at $5.10. The corresponding put options for May expiry, changing hands at $4.30 and $3.00 respectively, carry an implied volatility at the moment of a whopping 118% and 117%.
Relative to 30-day historical volatility in the 60s, May options are even more over-priced than the Apple (AAPL) options I mentioned in earlier articles. (See “With Apple Investors Worried, Pre-Earnings Option Pricing Looks Like an Opportunity” and “Follow-Up After a Successful Naked Put Write on Apple Prior to Earnings”.) However, that higher level of recent volatility does make it easier to see some rationale behind the extreme level of investor uncertainty that has led to such high demand for the protection of put options.
There are many other important differences between the two, of course.
In terms of price action, Tesla has been on a tear recently, putting on around 20 points in two months, while Apple had been on a steady decline prior to its last quarterly report. However, Apple’s long decline and consequent hammering by the mainstream media was accompanied by nothing like the levels of short interest displayed by Tesla, which has been one of the most shorted stocks around, just as it was last year. Even after its recent run-up, short interest remains extremely high, providing both a significant downside cushion for the stock and a reminder that genuine and large questions remain over the future of the company.
Most importantly of all, however, Apple was being discounted by almost hysterical levels of skepticism about its future prospects, while the price of Tesla reflects the possibility that its future may hold some truly great things. As of this moment, Tesla price action undoubtedly also reflects some degree of short squeeze underway for the last two months.
The aim of the strategy I outlined in the earlier article about naked put writing was to capitalize on the spike in implied volatility by writing relatively short-term puts just prior to earnings, either closing the position when volatility falls after earnings, or holding the position until expiry so as to acquire the stock at a discount upon assignment. In the case of Apple, the option premium represented less than 5% of the current stock price at the time, while in the case of Tesla, the option premium for the May 55 strike, which is currently out-of-the-money by more than $2, represents just over 5%, and the 57.50 strike weighs in at 7.5%. The additional time value of the June puts places those at nearly 9% and 11.5%. Given a higher margin requirement of 30% for Tesla, the total collateral requirement for the May out-of-the-money options, the most conservative of the set, is around $1990. The maximum profit on the lower-priced May option, $300, is therefore around 15% of the collateral requirement — or very close to what we saw with the Apple naked put strategy. The more aggressive strategy, with the higher-priced June option that is very slightly in the money, requires a higher level of collateral due to the higher strike and larger option premium, but it potentially delivers nearly 28% of maximum gain on that collateral commitment.
Given the giant short interest cushion providing additional insurance, in my view the higher June strike offers an attractive proposition. However, the speedier decay of time premium in the May options provides a greater opportunity to finish up with the position and move on to the next as rapidly as possible.
As in the case of Apple, a central question for any investor considering this approach is whether they are happy to buy Tesla anyway, in this case, at a price of $52 for the most conservative option or at a price of a little under $51 for the more aggressive June 57.50 strike. If you would not be happy buying Tesla anyway — for concrete reasons that go beyond the inflated option premium — then this approach ceases to become part of an investment strategy and looks more like short-term speculation.
All material on this site is carefully reviewed, but its accuracy cannot be guaranteed; please do your own checking and verifying. This specific article was last reviewed or updated by Dr Greg Mulhauser on .