*Explaining my fundamental analysis and the structure of my Tesla short trade position using Put options*
Welcome back to the blog! In this blog post I am going to show you something very different to my normal trading content. I rarely trade individual stocks and instead buy and sell stock market indices because I like the safety of diversification. However, I am always open to “special circumstances” trades and I believe shorting Tesla could prove to be exactly that.
99% of the speculative trading I do is spread betting; buying or selling FX currencies, stock market indices, commodities and volatility futures. This involves taking direct bets on value of instruments linked to the underlying assets or securities and making a profit or loss if the value of the underlying asset goes up or down in the direction of my trade. These types of trades have a Delta value of 1 because for every 1 point change in value of the underlying security (FX currency/index etc.) the price of the contract I am trading will change by 1. This is covered in more detail later in this post.
This works perfectly fine for my normal style of trading using the technical and fundamental analysis and risk management I regularly share on this blog. However, with my new Tesla short trade I have decided to structure it using something completely different… Options!
IMPORTANT! Before we continue, I would like to say that I have not suddenly become an options trading genius. I know the basics but I enlisted the help of a friend who works for a multi million dollar hedge fund to assist me with pricing and risk for this trade. As such, if there are any mistakes in this blog post then I do apologise in advance.
What are options?
Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futures contracts, the holder is not required to buy or sell the asset if they choose not to.
Call options allow the holder to buy the asset at a stated price within a specific timeframe. This is a bullish bet or a long position betting that the value of the asset will increase.
Put options allow the holder to sell the asset at a stated price within a specific timeframe. This is a bearish bet or a short position betting that the value of the asset will decrease.
The image above shows the 4 main types of options trades and how profit and loss is effected depending on the underlying price of the asset. A long put option is the standard bearish options trade used for profiting from a decrease in the price of an asset. In the case of my trade, the Tesla stock price is the underlying asset.
Tesla Inc. (TSLA) is is an American electric vehicle and clean energy company based in California. The company specialises in electric vehicle manufacturing, battery energy storage from home to grid scale and, through its acquisition of various solar product manufacturing.
Here are a few key facts about Tesla.
- Tesla are now the largest car manufacturer in the world with a market capitalization of $224 billion as of Friday 3rd July.
- Tesla market cap is larger than Volkswagen, Honda, Daimler (Mercedes Benz) and Ferrari combined.
- The stock price of Tesla has more than doubled since the start of 2020.
- As of July 2nd, the market cap of Tesla was bigger than the total market cap of Bitcoin!
So why am I shorting Tesla?
It might seem ludicrous (pardon the pun), to short a company that is now the biggest and seemingly best in its industry but that is exactly why I am now of the opinion that the stock price of Tesla will fall.
Here are a few more facts about Tesla.
- In 2018, the Tesla Model S came last in a survey of most reliable cars with a score of just 50.9%. Electrical systems and bodywork were the biggest issues. https://www.businessinsider.com/survey-uk-drivers-say-tesla-model-s-most-unreliable-car-2018-9?r=US&IR=T
- Since 2018, the majority of all warranty repairs on Tesla vehicles have been recorded as Goodwill. This “artificially” inflates gross profits and net income. https://seekingalpha.com/article/4313851-tesla-warranty-expense-case-of-goodwill-auditors
- Revenues grew to just under $24.6 billion in 2019 yet this still resulted in a net loss of more than $850 million! https://www.statista.com/topics/2086/tesla/
In my opinion, the financials of Tesla Inc DO NOT justify the current value of its stock and the company is too new and unestablished to have a decent supporting network of customers who will continue to back the company. I also believe that the majority of Tesla vehicle owners do not/will not own the companies stock because they know the product is not up to standard.
Fun Fact! The highest mileage Tesla vehicle in the world has completed around 400,000 miles. It is owned by a shuttle service in California and in the space of 3 years it has had it’s battery replaced twice! This is not only costly but also not exactly environmentally friendly.
Investors are buying Tesla stock out of euphoria and flock mentality. The stock price does not reflect the true financial value of the company as at today and instead, investors are buying in to Elon Musks visions for the future. This almost makes the buyers of Tesla stock similar to cult followers and we all know how that tends to work out.
My Tesla short trade.
My short trade on Tesla is a long put option trade. I have bought 34 shares of October 2020 TSLA Put options with a strike price of 1000.
The image above shows all of the key information relating to the trade. I have recorded it in a spreadsheet table for you so you can see it easier. As you can see, the total premium of this trade was $2,895.10 which is my risk. It does not matter how high the Tesla stock price rises in future, my maximum risk is capped at this price.
In regards to potential profit, this is where it gets interesting. As you can see, I have a strike price of 1000 with a premium of $85.15 paid per share. This means that if the stock price of Tesla reaches $914.85 at the date of expiry I will breakeven and lose no money.
Breakeven = Strike Price – Premium Paid.
If the Tesla stock price is lower than $914.85 between now and the date of expiry then I will make profit. Options profit and loss pricing is complex and exponential in its calculations because of time has an effect on value and an options contract generally loses value the closer it gets to maturity (expiration). This is called Theta decay.
The chart above shows the approximate potential profit and loss of my Tesla put option trade. As you can see, the date to maturity or duration of the trade effects the amount of profit I will make up to a certain point where Delta becomes 1 and the option becomes so far in the money.
In basic terms, this means that if I wasn’t to hold this trade until expiry and sell my options early, the date I sell at will effect the amount of price profit (or loss) I might make. The longer the time left to maturity, the greater the profit I can make so it would benefit me if the stock price of Tesla dropped sooner rather than later.
The table below shows more detailed potential profit or loss depending on the underlying stock price of Tesla and the date I might sell at. To see the full table, click on the link below the chart.
Why am I using Options for this trade?
By trading options contracts, I can cap my risk whilst gaining exposure to a product that will have a delta of almost 1 at expiry if price drops to my intended target price of 500 or lower. The chart below shows the approximate Delta curve for this trade.
Delta is the ratio that compares the change in the price of an asset to the corresponding change in the price of its derivative. In this example, if the Tesla stock option has a delta value of 0.65, this means that if the underlying stock increases in price by $1 per share, the option on it will rise by $0.65 per share, all else being equal. However, as you can see, the further the stock price falls, the greater the delta is and this means my potential profit increases.
Shorting Tesla via put options also allows me to set my required amount of risk, in this case its $2895.10, which will not be effected if the stock price continues to rise infinitely. All whilst getting access to potential profits which will increase as the stock price falls further.
If I was to simply short the underlying asset, the Tesla stock, then I would have to try and figure out the upside potential for the stock price in order to manage my risk and position sizing. This would then have a direct impact on my profit. Unfortunately, I have no idea what Tesla stock might do in the near term but I am of the opinion that at some point in the next 3 months it will fall. By buying put options I have the ability to be massively wrong about the stock price in the short term but still be able to profit if my bearish prediction correct at some point in the future.
There is every chance that the stock price of Tesla will continue to balloon up to $1500 or even $2000 per share according to some Wall Street analysts. However, even if that does happen, my risk is capped and it will prove even more unsustainable and so long as price then falls down below my breakeven level then I will profit.
If you look back at the history of Tesla stock prices, you will see that it is heavily influenced by Elon Musk and his social media. We all remember the infamous “420” tweet and the more recent “Tesla stock price is too high” tweet. The chances of this happening again in the next 3 months are very high in my opinion and it only takes 1 thing to scare investors to send the stock price crashing once again.
I am very interested in hearing your thoughts on Tesla as a company and their current stock price because it is definitely a topic that is dividing opinions across social media. Please leave a comment if you have agree or disagree with this trade.
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