by John Kmiecik | October 11, 2013 7:59 am
Let’s be honest: All trading is inherently speculative. We know as traders that we are always trying to put the odds on our side to profit. This trade idea on Tesla Motors (TSLA) might not put the odds are your side, but the risk/reward ratio looks awfully tempting especially based on a slightly bullish outlook.
The trade: Buy the TSLA Oct 175/180/185 Call Butterfly Spread (buying the October 175 call, selling 2 Oct 180 calls and buying the Oct 185 call) for 95 cents or less.
The strategy: The maximum potential profit for this trade is $4.05 if TSLA is trading right at $180 at October expiration. The long 175 call option would have $5 worth of premium, and the other options would expire worthless. The cost of the trade is then subtracted ($5 – $0.95). The maximum loss is 95 cents or what was paid for the spread if TSLA is trading below $175 (all options expire worthless) or above $185 (all options would have to be bought or sold) at October expiration. Breakeven is at $175.95 and $184.05 at expiration based on a cost of 95 cents.
The rationale: A butterfly spread is normally a speculative trade to some degree, but with the current market situation it is probably a little more speculative than usual. However, the reason this TSLA trade idea looks inviting is because of the risk/reward ratio and breakeven points of the trade.
Click to Enlarge We can talk about Tesla stock and how the company is doing, but really this trade idea comes down to expiration next week. TSLA has been on quite the run higher for several months and just recently pulled back in part because of the market selloff. With the possibility of a resolution to the government crisis, Tesla stock might once again try to move higher as investors might see this as a cheaper time to buy.
The $180 level was chosen for the body of the butterfly (max profit area) because of a minor pivot level (support) in that area back in late September. Tesla stock might try to climb back to that area by October expiration and encounter some resistance, which was previous support. Since this is a butterfly spread, there is a little bit of room for a margin of error.
I don’t know if electric cars are the wave of the future for sure, but the way TSLA has been rising in the past, asking it to move just a little higher in about a week seems sensible.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities. Get a free trial of John’s live options trading room here.
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