While Tesla Inc (Nasdaq: TSLA) has remained one of the most-shorted stocks in the New York Stock Exchange, retail investors have also taken advantage of the volatility in the electric auto manufacturer’s shares by buying puts.
Options traders have earned millions of dollars since Tesla’s CEO Elon Musk infamously tweeted that he was taking the company private at $420 a share on Aug. 7, sending TSLA stock into a tailspin. Late Friday, Musk announced he was abandoning the effort, sending TSLA stock down again.
His unorthodox method of sharing his intentions of the company via Twitter was unprecedented, and raised more questions on whether Musk had committed a securities offense.
Short sellers have pocketed an even larger profit of $1.2 billon as of Aug. 17 since the tweet, according to data from S3 Partners, a New York-based financial analytics company. Musk’s tweets and interviews with the media have had a “volatile effect on both Tesla long and short shareholders,” says Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, in a report.
[See: 7 of the Best Stocks to Buy for 2018.]
Tesla remains the largest equity short in the U.S. with $11.2 billion of short interest, 33.4 million shares shorted or 26.2 percent of its float, he wrote.
Musk’s tweet only drove away less than 4 percent of the short sellers who only covered 1.3 million shares since Tesla’s original stock price spike, Dusaniwsky says. “In actuality, many of the longer-term short sellers have backed up their bets and slightly increased their short exposure over the last week,” he says in the report.
Now that Tesla is undergoing intense scrutiny as the Securities and Exchange Commission conducts an investigation and is the target of two shareholder lawsuits as suspicion grows on whether Musk actually negotiated and “secured” the funding necessary to take the company private. The SEC is also investigating the accuracy of Tesla’s Model 3 production claims.
Analysts have raised their doubts that Tesla can meet its financial targets and whether the Saudi Arabian sovereign fund will make an investment. J.P. Morgan analyst Ryan Brinkman lowered his target of Tesla to $195 on Aug. 20 and says he is no longer assigning any value to the potential privatization deal. The bank’s downgrade follows Vertical Group which slashed its price target to $88 last week.
The stock has remained volatile since Musk signaled his intentions and shares dipped by 18.7 percent since Aug. 7. Citi Research analyst Itay Michaeli says Tesla should consider raising capital in the near term. The company has $10 billion in debt, remains unprofitable and will likely need to raise capital this year.
One way for investors to protect themselves is to buy a put, says Ron McCoy, chief investment officer at Freedom Capital Advisors in Clermont, Florida. The put options are not cheap due to the extreme volatility.
If an investor owned 100 shares of the stock, he or she could buy one put to cover those 100 shares and have the right to put someone the stock at some point in the future if the stock declines, he says.
“It’s often called a married put and can help protect against the downside and allow for profits on the way up,” McCoy says. “It’s like buying insurance and can get expensive.”
The August 2020 $320 at the money puts were trading for $64.50 last week, which is about 20 percent of the underlying stock.
[See: The 10 Most Valuable Auto Companies in the World.]
“It’s not very cheap, however the shorter-term options would cost less,” he says.
Peter Roselle, a Treasure Coast, Florida-based trader, has been buying puts on Tesla for the past six months due to concerns about its future earnings. He began adding longer-dated puts in June such as the January 2019 $270 strikes and the August 2019 $225 strikes. This gives investors the possibility of selling the “front weeks/months” to reduce the cost of the long-dated puts and taking advantage of the very high implied volatility, he says.
“You certainly could be selling the Sept. 30 $250 puts, which are trading at $5.60 against the January 2019 $270 put and collect a pretty good premium,” Roselle says.
The catalysts that will drive TSLA stock lower will likely occur before those dates, he says.
“There is a lot that Musk can do to drag out the life of Tesla by massaging the balance sheet and leveraging with the SEC,” Roselle says. “What I lost in time premium, I gained back by selling the crazy volatility spikes.”
January options will allow traders to capture any downside from the result of third-quarter earnings.
“If you’re too aggressive with September and November 2018 puts, your positions could expire before the story is over,” he says.
Very few stocks have an implied volatility this high. The Aug. 31 $245 puts are trading at $1, which is $70 lower than the current price.
“There is a massive amount of premium for a company who has the potential to file for bankruptcy,” Roselle says. “You can snake money by selling the front week (closest contracts).”
His first short position occurred in early April when he purchased $265 strike puts expiring in May.
“I promptly was handed losses as I got too aggressive in positioning for a further move down over the next three months,” he says. “The stock would run all the way to $370 in mid June.”
Although shares of Tesla could move much lower than the current price, it may take time to play out, says
Christopher Irons, founder of Quoth the Raven Research, a Philadelphia-based financial research company, has been buying and selling options on Tesla for a year.
[See: Artificial Intelligence Stocks: The 10 Best AI Companies.]
He has bought both longer-dated out of the money puts while at the same time hedging by purchasing short-dated calls. He also usually owns cheap, very short-dated out of the money put options that he rolls over every couple of weeks.
The future of Tesla remains questionable and much of it depends on what action the company’s board of directors pursues.
“If the SEC sues the company and Musk leaves, the stock price would likely move lower overnight, but whether the ultimate outcome — be it a restructuring for its creditors, recapitalization, go private offer or bankruptcy — it’s going to take some time,” Irons says. “The board has to start paying attention instead of letting him do what he wants.”
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How Investors Can Short Tesla Inc (TSLA) Stock With Options originally appeared on usnews.com
