Converting My Tesla Short Trade!

*I have converted my Tesla put options into a put spread trade to return some profit from a potential losing trade*

Welcome back to the blog. In this Wednesday blog post I am going to explain to you how I have modified my original Tesla short trade in order to potentially profit from an almost certain loss thanks to the incredible market volatility seen recently and some stock options trading trickery.

If you haven’t read my previous blog post explaining why and how I shorted Tesla then you can find it by clicking on the link below.

https://diaryofafinancekid.com/2020/07/05/i-have-shorted-tesla-tsla/

I shorted Tesla Inc. (TSLA) via put options. These are a financial instrument used for a bearish bet on the underlying price of an asset or security. I bought October 2020 1000 Puts which meant that I would make money if the stock price of Tesla was below 1000 (excluding premium paid) at the time of expiry on the 16th October 2020.

The charts below shows the forecast delta and potential profit/loss depending on the underlying stock price at the time of expiry and at the end of each month in-between.

However, as everyone is now aware, the stock price of Tesla continued to climb… rapidly! Within a week of me purchasing my put options the stock price had climbed another $200 per share. 2 weeks later Tesla created an all time high price of almost $1800 per share! ($1794.99).

My initial target for Tesla was anywhere below $900 per share. This would equate to a 25% drop in price. However, as price soon broke above $1700 per share, the same 25% drop in price (down to $1275) would leave me with worthless put options at expiry because my original strike price was 1000. In order to just breakeven at expiry on my original Tesla put options I would need the share price to drop by just under 50% from the all time high prices seen this month. Therefore, I began to feel like my original thesis on Tesla being over valued at $1200 per share was still correct in principle but no longer correct in todays crazy market conditions.

However… these same “crazy market conditions” that are pushing the underlying stock price of Tesla up to new highs also helped my turn my seemingly lost cause of a short trade in to a potential profit.

This is where the put Spread trade occurred.

To explain how this new trade works I will try to keep things simple and start by showing you the 2 parts of the trade side by side. Then I will show you the current floating profit and the potential outcomes for the trade depending on what the price of the underlying stock does.

Okay, so originally I bought put options to directly benefit from a drop in the underlying stock price. This is a bearish trade and I would not make any profit unless the stock price closed below the strike price (minus premium paid). However, as explained earlier, the price of Tesla shares continued to climb and profiting from this original trade seemed less and less likely each day.

At the same time as the stock price was moving in the went direction, Implied Volatility (IV) was increasing at an even greater rate. As you can see in the data above, IV increased by more than 65% whilst the underlying stock price only moved 25.83% against me and this is why earlier in this blog I mentioned that the “crazy market conditions” (increased stock market volatility) has allowed me to potentially profit from a short trade despite the Delta moving against me.

Important! Please read my previous Tesla short trade blog post for the definitions and explanations of options trades and their components such as Delta, Theta and P&L calculations.

Higher levels of Implied Volatility = Higher Options Premiums. Therefore, this put spread trade becomes a profitable strategy for me because Implied Volatility increased by more than the underlying stock price increased.

The second trade was therefore me selling the same number of Tesla put options with the same expiry date but slightly higher strike price for a much higher premium than what I paid originally. The difference between premium paid and premium received is my theoretical net profit that I have earned and this is shown on the data above.

Net Profit = Premium Received – Premium Paid = $3,587.00 – $2,895.10 = $691.90

The new profit and loss chart for the put spread trade is below.

As you can see, the profit and loss curve looks completely different to the original trade where I was just buying put options. Although this losing trade has now theoretically been made profitable, there are new caveats to whether this profitability remains.

Comparing the trade scenarios.

On my original trade I had a breakeven price of $914.85 which is calculated by subtracting the premium paid from the strike price of the options. This means, at the expiration date in October, I would not have made any profit unless the stock price of Tesla was trading below $914.85.

As at today (22/07/2020), the current share price of Tesla is $1605. This means I would have needed the share price of Tesla to drop by 43% in order to just breakeven. If the stock price is trading above $914.85 at expiration then I would lose all of my premium paid which was $2895.10. This is my maximum risk.

Alternatively, the new put spread trade works in reverse. I am now currently in profit thanks to the difference in premiums paid and received as explained earlier in this blog. However, if you look at the new profit and loss chart shown above, you can see that this profit remains mine until the underlying stock price drops below $1100 per share. My new breakeven price level is $1080 per share. So long as the price of Tesla stock remains above $1080 I will no longer lose $2895.10

At the same time I have also managed to reduce my maximum risk with this trade (from £2895.10 to $2708.10) although this has come at a cost of losing the maximum profits that were previously planned with the original put trade.

End note.

It could therefore be considered that I am now bullish on Tesla but in reality what I have done is damage control with this put spread trade. Having looked at price action and the heavy buying of Tesla stock since first purchasing my put options, I have realised I was wrong to start with.

I do believe Tesla is overvalued according to traditional accounting methods but unfortunately it seems that others do not have the same views and Tesla is not a traditional company. Stock prices are calculated on the future earnings of a company and it appears buyers of the stock believe the future is very very bright for Tesla.

Useful Links:

All my technical analysis is done using the TradingView platform. You can get access via the link below.

https://tradingview.go2cloud.org/SH3bP

My preferred broker of choice is IC Markets. Low spreads and trading costs really help long term profitability. A link to their site is below.

https://www.icmarkets.com/?camp=38537

FTMO Trader Funding Programme.

https://ftmo.com/?affiliates=335

Thanks for reading and please don’t forget to LIKE, SHARE and FOLLOW my blog to stay up to date with the latest market analysis and trading education posts.

DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.

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