Shares of Tesla recently broke above $2,000, creating hysteria among investors who think the stock will rally higher and others who think it will soon collapse.
The argument has occurred for most of Tesla’s existence—and typically centers around valuation. Some people think the company is trading for far more than it is worth. Others see the stock as undervalued as the future of electric cars is unlimited. The argument often shifts from the objective to the subjective, and an impending stock split has exacerbated passions.
Shareholders of record on Aug. 21 will receive a dividend of four additional shares of common stock that will be distributed after the close on Friday. The five-for-one split will make the stock more affordable, and likely push the speculative frenzy that follows Tesla into a new phase.
The lack of impartiality on Tesla arguably creates a needed bullish tension assuming the company continues to release sales data and forecasts that suggests Tesla’s cars are in great demand.
The view might seem superficial, and perhaps an oversimplification of a complicated situation, but right now such simplicity seems to be the right stance. Investors are mad with desire for Tesla, and the stock’s performance reflects as much.
We have previously harnessed the momentum of the stock, and the psychology of the crowd, and now it is time to do so again. The stock has surged so much, so fast, that a strategy recommended not long ago must now be adjusted to secure profits. All options contracts are adjusted to reflect stock splits.
Tesla’s stock is moving around in extraordinary ways, sometimes swinging as much in one day as many stocks are worth. When using options on such a stock, a goal is to try to profit from the momentum.
Consider this trade an example of how an aggressive, wealthy investor might harness Tesla in the options market: when the stock was at $2,014 early Monday, the September $1,950 put could have been sold for $140 and the September $2,100 call could have been bought for $135.
The risk-reversal strategy—that is selling a put and buying a call with a higher strike price but same expiration—was chosen to generate a credit. Look at how much Tesla’s stock price has danced around since the trade was first priced—and understand that the extraordinary volatility represents extreme risk and potential reward.
The great risk to the strategy—and it cannot be overstated—is that Tesla’s stock collapses and the stock tumbles far below the put strike price. If that happened, investors would have to buy the stock at the put strike price even if the stock was sharply lower, or they would have to cover the short put. In totality, the short put is a big risk factor.
To minimize risk, the September expiration was chosen. Options lose a little value each day, and the September expiration provides enough time for the stock-split mania to keep working, and for time decay to also work its magic.
During the past 52 weeks, the stock has ranged from $211.54 to $2,129. Shares are up 382% this year, and 837% over the past year.
The trade replaces a previous recommendation, made when Tesla was around $1,637, to buy the January $1,650 call and sell the $1,750 call for $40. The spread was worth a maximum profit of $60 if the stock was at $1,750 at expiration. We would normally wait to adjust the spread until expiration, but the stock price has advanced so much that it now needs to be addressed.
The call spread—buying a call and selling another with a higher strike price but same expiration—replaced another trade recommended when Tesla’s stock was at $994.32.
Without a doubt, the aggressiveness of Tesla’s stock moves has been surprising, and it often seems the stock advances simply because the market mob wants it to advance. If you want some fundamental reason why Tesla’s stock will keep rallying, there is none.
It is impossible to know if Tesla will sell more cars, or turn another quarterly profit, or anger investors, and in many ways, it doesn’t matter. Tesla has decided to split its stock, and each share will soon morph into five. When that happens, the hot stock will be so attractively priced that any tyro with a Robin Hood account, and a few thousand dollars, can try their luck making a buck.
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Originally Posted on August 25, 2020 – Tesla’s Stock Split Is Looming. How to Play It With Options.
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Disclosure: Options Trading
Options involve risk and are not suitable for all investors. Multiple leg strategies, including spreads, will incur multiple commission charges. For more information read the "Characteristics and Risks of Standardized Options" also known as the options disclosure document (ODD) or visit ibkr.com/occ
