Tesla Motors Inc (TSLA) is a Wall Street darling, which probably makes me a villain for posting this short Tesla stock idea. I have successfully shorted it in the past using the options markets with limited risk. I want to repeat that performance through its coming earnings.
Tesla stock trades at valuations that are usually reserved to high-tech growth stocks. I hold much less optimism than TSLA fans do. I think it needs several miracles before it can deliver on its expected potential.
With hotly contested stocks like TSLA, it’s best to leave emotions out of trading. Dealing with thousands of traders, I find that too many become fans of the stocks just because they like the product.
By shorting Tesla stock I am not saying that I hate the product. It’s simply my interpretation of current price versus expectations.
Click to Enlarge Tesla’s struggle is not with demand but with a slew of operational hindrances. Even though the Model X has so far disappointed, the recently announced Model 3 was an instant hit in preorders but is far from a reality.
While shorting Tesla stock, I never underestimate the love that Wall Street has for TSLA CEO Elon Musk. He has a habit of posting blurbs that often translate into a price spike. TSLA stock fans don’t mind chasing new highs without any new fundamental reason to do so; I respect that fact.
Tesla Stock Trade
My strategy is a pair trade, first buying a put spread, then financing it by selling cautious calls.
- Trade No. 1: Buy TSLA May $222.50/$220 debit put spread. This is a bearish trade for which I pay $1 per contract. If Tesla stock falls through both legs, I stand to double my money. This makes it a coin flip trade, which is apt for an earnings play. If TSLA holds above $220 through expiration, this would be my max potential loss.
Instead of risking the full debit on earnings I will sell calls to lower my entry cost.
- Trade No. 2: Sell TSLA September $300/$305 credit call spread. This is a bearish trade for which I collect $.55 per contract. This trade would come under pressure if earnings cause TSLA stock to spike sharply.
Riskier appetites could sell the Sep $310 call naked and collect $4 per contract. But that would expose the trade to unlimited losses on a massive spike. When I opt to sell such a call naked, I usually buy a cheap weekly call to cover the unlikely scenario of a mega spike. In this case it would be the TSLA May 6 $290 call for ten cents or less.
For maximum profits, I need Tesla stock to fall below $220 on earnings and stay below $310 through mid-September. Should my thesis change, I can close either of these trades at any time for partial profit or loss.
The options markets offer me hundreds of ways I can trade my thesis. It is important that I never take trades I don’t understand and I only risk money I can afford to lose.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
