Tesla is Strong But Overbought

You can profit as it pulls back

Tesla, Inc. (NASDAQ:TSLA) has risen by over 200% since it bottomed out at $176.99 in June 2019. While I don’t think it will fall all the way back down, I do think the stock will pull back in the short term.

The stock has already started turning to the downside this week. It could either be from investors’ general fear over the coronavirus outbreak or from profit taking now that the stock has pushed above $550 per share.

Though the company has strong fundamentals, there are technical reasons to think TSLA will continue its drop lower.

The FOMC and TSLA’s Earnings Report

The Federal Open Market Committee (FOMC) is holding its first meeting of the year this week. According to CME Group’s FedWatch Tool, most federal funds future traders are expecting rates to remain steady.

Traders should have already priced that into the market, but there’s no telling how people will react to the statement after the meeting on Wednesday.

If traders hear something they don’t like, they might be inclined to push the market lower, which could affect an overbought stock like TSLA.

TSLA’s earnings report also gets released on Wednesday, after market close.

The company managed to beat earnings in the third quarter, when it was expected to report a loss of $0.15 per share. It came in with $1.86 earnings per share, which was a huge surprise.

Many analysts expect continued growth in Model 3 sales to keep earnings positive, which should lead to more growth in the stock. Based on TSLA’s technical picture, I think the stock still has further to fall.

Overbought Territory

Looking at the chart below, you can see TSLA’s bottom in June 2019 and its impressive recovery. You can also see the pullback that started after the stock failed to clear the $575 level three sessions in a row.

Daily Chart of Tesla, Inc. (TSLA) — Chart Source: TradingView

At the bottom of the chart, you’ll notice I’ve included TSLA’s relative strength indicator (RSI).

Above, I mentioned that TSLA is “overbought,” and as my regular readers know, traders can use a stock or index’s RSI to determine whether it is in overbought or “oversold” territory.

Typically, an RSI reading above 70 tells traders that an asset is overbought, or overvalued, while a reading below 30 tells traders that an asset is oversold, or undervalued.

TSLA’s RSI has been above 70 since December, and I think it is overdue for a correction. Even the most recent pullback didn’t take its RSI below 70.

A bigger pullback wouldn’t necessarily mean that it’s time to get bearish on TSLA, but it would give the stock time to consolidate before heading higher. Traders have an opportunity to profit from the pullback with a calendar put debit spread in the meantime.

TSLA is unlikely to drop back to the low $400 range, which makes those options cheap. However, if its earnings are weak or investors decide to take profits before something sends the stock lower, options with far out-of-the-money strike prices will still gain value.

Using a spread order, buy to open the TSLA Feb. 7th $390 put and sell to open the TSLA Jan. 31st $420 put for a net debit of about $0.25.

Note: Be sure you are buying to open the weekly TSLA options that expire on Friday, Feb. 7, 2020. Be sure you are selling to open the weekly TSLA options that expire on Friday, Jan. 31st, 2020.

This is a very high-risk trade, so take a small position.

About Calendar Put Debit Spreads

A debit spread is simply a way to lower the cost of buying options, as the option that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this calendar put debit spread is a way to lower the cost of buying bearish put options. Many brokers will require the use of margin and/or a set amount of reserved capital to execute a debit spread; contact your broker directly for specific requirements.

In this case we want TSLA to remain above $420 per share through the short option’s Jan. 31 expiration. Then we would like to see it fall toward $390 before the long option’s Feb. 7 expiration.

InvestorPlace advisor Ken Trester also brings you Power Options Weekly, which delivers 5 new options trades and his latest trading advice to you each Friday. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.


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