Behold, the TSLA Knife Catch!

by Tyler Craig | November 11, 2013 11:11 am

Tesla Motors (TSLA[1]) has been thoroughly thrashed since daring to disappoint the Street during last week’s unveiling of its latest earnings. Sure, expectations were high, but aren’t they always after a stock has been gifted with a 400% gain on the year?

In surveying the post-earnings wreckage, two things become apparent. First, Tesla stock is reaching extremely oversold conditions. Second, Friday’s price action in TSLA suggested a bounce might be imminent, which we’re beginning to see this morning.

TSLAstock 1024x798 Behold, the TSLA Knife Catch!
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Even the most vicious stock downturns are interrupted by the occasional relief rallies as short-sellers buy up shares in a bout of profit-taking. Remember: There are two groups of buyers in our little financial playground. One group of bulls buying to go long a stock and one group of bears buying to cover short positions. While the first is buying to enter a position, the second is buying to exit.

Given the 25% three-day plunge in Tesla stock, it’s fair to say more than a few bears are eying the exit door with interest.

Candlestick analysis lends some additional weight to the argument for at least a pause in the stock slide. Friday’s formation has bullish implications for two reasons. First, the long, bottoming tail (i.e., lower wick) reveals the bullish intraday reversal that carried TSLA well above its lows for the day. Second, the green real body shows the bulls were able to win the day by driving Tesla stock higher than it opened in the morning. Although it would have been an even more potent reversal candle if TSLA would have closed at the highs of the day, it does at least suggest dip buyers are starting to take a bite of these depressed shares.

Some might say TSLA looks like a falling knife, and perhaps there’s some truth to that. While knife-catching often turns bloody, the Tesla options market at least provides an added measure of safety when playing with daggers.

With Tesla stock trading at $143, you could sell the Dec 115-110 put spread for approximately 55 cents. The position is entered by selling to open the Dec 115 put and buying to open the Dec 110 put. The max reward is limited to the initial credit of 55 cents and will be captured provided TSLA sits above $115 by December expiration. Since the 115 put has a delta of 13, the probability of making the profit is 87%. The max risk is the distance between strikes minus the net credit, or $4.45. However, to reduce the risk, you could exit if TSLA falls below $115 in the coming weeks.

So where does the added safety come in? Consider the additional room afforded by selling this put spread vs. buying Tesla stock outright. If you bought the stock at $143, you’re immediately losing money under that price. If instead we sell the 115-110 put spread for 55 cents, then your cost basis or breakeven at expiration is all the way down at $114.45.

In sum, the put spread is a much higher-probability bet than buying TSLA.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. TSLA: http://studio-5.financialcontent.com/investplace/quote?Symbol=TSLA

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