Shares of electric truck maker Nikola Motors (NASDAQ:NKLA) continue to defy gravity after a parabolic rally. Nikola stock has been on a wild ride in June. Shares ran from $28.70 all the way to $93.99 before dropping back to the current levels around $65.
Certainly much of this insane price action was caused by a short squeeze, as shares are difficult and expensive to borrow due to the small float. This difficulty, however, sets up an advantageous opportunity in options for those looking to buy Nikola stock.
Nikola stock is difficult, if not impossible, to borrow to short. Stock borrow rates for those able to locate shares are at extremes. This certainly has fueled some of the recent short-squeeze rally evident in NKLA. It also skews normal option-pricing relationships as puts trade at a massive premium to their corresponding calls.
Normally, the calls and puts would trade at similar implied volatility levels owing to put-call parity. If the options were at different IV levels, however, then traders could arbitrage the difference and capture a small risk-free profit. To enact this arbitrage, traders have to be able to borrow the stock.
Taking a Look at Implied Volatility
Below is the July option montage for Arena Pharmaceuticals (NASDAQ:ARNA), which closed at roughly the same price as Nikola stock. The calls and puts carry about the same implied volatility (IV) of 59. Calls are priced $3 higher than the puts, which makes sense since ARNA stock is trading at almost $63 and we are looking at the $60 strike.
The option montage shows the at-the-money July options from yesterday’s close for Nikola stock.
Since NKLA is hard to borrow to short, puts become more valuable as a short surrogate. The July $60 puts are trading at a 428 implied volatility while the July $60 calls are trading at only a 100 IV. Compare that to our previous ARNA example where one can easily borrow ARNA stock.
One can create a synthetic long stock position by buying the July $60 calls and selling the July $60 puts. This is called an option combo and mirrors the P/L of a similar long stock position. Normally, the July $60 calls would carry a larger premium than the puts since the calls are in the money and the puts are out of the money. One would then have to pay to buy the calls and sell the puts to create the synthetic long stock position.
How to Trade Nikola Stock Here
In the case of Nikola stock options, that relationship is out the window. The July $60 puts are priced at around $27.50 while the corresponding July $60 calls are trading near $8. Rather than paying to buy the combo, buying the calls and selling the puts would instead bring in a massive net credit of $19.50.
This effectively means one can buy Nikola stock at $40.50 ($60 strike less $19.50 credit received) by using the combo strategy instead of buying the stock outright. By doing so, one can get a 35% discount. Selling a further out-of-the-money July $70 call against the combo can reduce the net cost by an additional $5, although it caps off the upside at $70.
An important caveat is that one needs to hold the combo until July expiration to receive the full discount. The discount will slowly ebb as a function of time, though. But for traders looking to take a long position in Nikola stock for at least a month, the options market can provide a dramatically less costly alternative.
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 weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.