Following a rip roaring 67% rally off the Feb. 10 low of $143.67, shares of Tesla Motors Inc (TSLA) look to be showing signs of fatigue. TSLA stock had rallied for seven straight days before finally closing lower Tuesday.
Click to Enlarge Given the magnitude of the rally and the overbought level, I think a pullback in Tesla is certainly in the offing.
After breaking below and then back above the $180 support level, Tesla stock had risen to a extremely overbought reading of 78 on a 14-day RSI basis. Over the past two years, TSLA stock had been this overbought only once before, which also happened to mark the all-time high in Tesla of $291.42.
Tesla stock is also running into some significant resistance at the $240 level, which was the closing price from Dec. 31. TSLA has attempted to break out above this $240 level over the past two trading days, only to fail and close below it.
Click to Enlarge Tuesday’s price action was also a reversal pattern, with the stock attempting to make a new high only to fail and close lower on the day.
This type of price action many times signifies that the trend may be coming to an end, as the buyers are finally showing signs of exhaustion.
Click to Enlarge Tesla stock, which is normally correlated to the price of oil, is also getting extended on that metric. While crude oil has leveled off since making a recent high on March 17, shares of TSLA continued to push higher by 3.5%.
Look for this correlation to converge, with TSLA stock being a relative underperformer to oil over the next month.
Implied Volatility (IV) is also priced at a relatively low level (37% percentile), showing signs of complacency. Low levels of IV are usually a reliable bearish indicator. Low levels of IV also mean option prices are comparatively cheap, which favors long option trade structures.
So to position for a pullback in Tesla stock, I am looking add a put diagonal spread. Specifically, I would buy the monthly TSLA April $230 puts (expire April 15) and sell the weekly April $220 puts (expire April 8) for a $6 net debit.
The trade is 13 deltas short at inception, with the maximum gain realized if TSLA stock closes near $220 on April 8. The maximum loss is limited to the initial debit paid of $600 per spread.
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.
