Ever since hitting lows around $180 in early December, Tesla Motors Inc (NASDAQ:TSLA) has rebounded 22% — far outpacing the S&P 500 and Nasdaq-100. However, just as the previous selloff in Tesla stock was overdone — as I have mentioned before — so too is this rally.
Now, I’m looking for TSLA shares to consolidate around the key $220 level over the coming weeks.
From a technical perspective, Tesla stock is showing some extremely overbought readings, with the 9-day RSI at nearly 85. Previous instances when Tesla stock reached such levels proved to be very opportune times to take a short position in TSLA stock.
One of the biggest drivers of Tesla’s recent monster rally may have been short covering. TSLA stock was the second-most shorted Nasdaq stock as of Dec. 15, with days to cover at 8.72. The average Nasdaq-100 stock had a days-to-cover measure of just 3.51. So it’s likely that much of the rally since Dec. 15 can be attributed to shorts covering before year’s end.
But with the shorts obliterated, Tesla shares may no longer enjoy this benefit.
In a previous post on TSLA, I highlighted how $220 was the number to watch in Tesla. Certainly that still applies. Tesla stock has once again returned to that critical level. Given the magnitude of the recent move, I think TSLA will encounter difficulties moving past this key area — at least in the short-term.
Yesterday’s price action was telling, with TSLA stock opening past the $220 level and trading higher, only to succumb to selling pressure and closing back below $220. This type of reversal day — especially at a key inflection point and following 10 days of gains in the past 12 — often signals that the buyers have become exhausted.
To position for a stall in Tesla’s recent rally, I prefer a short call spread.
How to Trade Tesla Stock Here
Buy the TSLA Jan $237.50 calls and sell the TSLA Jan $235 calls for a 50-cent net credit.
These are the traditional monthly options that expire Jan. 20, 2017, well before Tesla’s earnings report, expected to come Feb. 8.
Maximum gain on the trade is $50 per spread. Maximum risk is $200 per spread. Return on risk is 25%.
The short $235 strike is positioned 6.9% higher than the $219.74 closing price of TSLA stock, providing a nice upside cushion. This also aligns with Tesla’s late July highs.
I would close out the trade on a meaningful move past $235 while looking to have the spread expire worthless and keep the initial $50 credit if TSLA stock remains well-behaved.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
