Bulls make money. Bears make money. Pigs make more money.
Rather than getting slaughtered—the traditional fate of greedy investors—extraordinary gains have been flowing to those using call options to wager on rising stocks.
The phenomenon has even changed a foundational pricing dynamic in the options market. Bullish calls—which increase in value when stock prices rise—now often have a higher implied volatility than bearish put options, which investors buy to hedge stocks. Stocks have risen for so long that greed, rather than fear, now defines options trading.
This unusual phenomenon reminds one of those halcyon days before February 2018, when a small handful of options funds were wagering on persistently low options volatility. The trades ultimately failed, sending the Cboe Volatility Index, or VIX, up 115% in one day while stripping 4.1% from the S&P 500 index.
It’s hard to know if this obsession with buying call options to profit from rising stock prices foreshadows a messy finish, but it’s hard to see it ending elegantly.
The call-centric approach is increasing in intensity, mirroring the explosive growth in options trading. The trade has rewarded many people who probably don’t realize—or care—that sophisticated traders usually sell options to profit from elevated volatility.
Many of these traders are selling December calls on major stocks, including Tesla (ticker: TSLA), Honeywell International (HON), Broadcom (AVGO), PepsiCo (PEP), Intuit (INTU), and others that dominate the market narrative.
The sale of calls by institutional and high-net-worth investors indicates a willingness to sell stocks at higher prices. The market mob would rather buy options that expire in a week or slightly more. They probably don’t care that call volatility levels are so high that the associated stocks must make extraordinary moves for the bets to prove profitable.
Such price insensitivity indicates extreme sentiment. It’s the type of disparity that one typically sees at market turns.
The elevated call skew—call it the “porcine premium”—is evident in benchmark exchange-traded funds, including Invesco QQQ Trust (QQQ), iShares Russell 2000 (IWM), and to a lesser degree in the S&P 500, Chris Jacobson, a Susquehanna Financial Group strategist, recently told clients. He diplomatically noted that the rise of call-implied volatility as stocks rally signifies a continuing advance or overexuberance.
Time will tell, but until then, aggressive traders can embrace the market’s zeitgeist via Tesla. By buying a call and selling a put, the options market essentially pays investors to trade the electric-vehicle maker. With Tesla stock at $1,067.95, the January $1,000 put could be sold for about $86 and the January $1,160 call could be bought for $85.
The risk-reversal strategy—buying a call and selling a put with a lower strike price but same expiration—profits from gains and obligates investors to buy the stock at lower prices. At $1,760, the call is worth $600. If Tesla is below $1,000, investors must buy the stock, or adjust the put to avoid that.
Tesla stock trades around 344 times earnings and is near the top of its trading range. It has tripled over the past year, though it recently fell after CEO Elon Musk asked his 63 million Twitter followers if he should sell some of his 171 million shares. The mob said yes, but the stock could just as easily rise on another tweet poll or whim.
We have recommended investors embrace Tesla since the stock was just above $100. We still believe that, though the risk dynamics of the strategy outlined above are more focused on the market mob than the company’s potential.
Originally Posted on November 11, 2021 – How to Ride Tesla Stock in a Greedy Options Market
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.
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