I recently published an article on Tesla Motors (NASDAQ:TSLA) entitled "Is Tesla Motors Setting Up To Be The Monster Short Squeeze Of 2013?" After posting the article, a question I received in the comments section was about how hedged the 31 million shares short might be. First, this article is not about making an option trade, it is showing you analysis of one reason why taking a long position in TSLA places you in position to participate in a potentially large stock run due to a short squeeze. On the flip side this article will inform those who have chosen to be short TSLA the risk inherent of a potential stock squeeze.
The best way to hedge if you chose to be short TSLA stock would be to own call options (generally out of the money would be the way to do this). Therefore, I took a shot at analyzing this through looking at current call option open interest in TSLA. If you are not interested in the specifics of my analysis you can jump to the last few paragraphs for the conclusion.
So, let's talk about how you would hedge if you had a short stock position. Generally, the way you would do this is through buying calls options which would be out of the money (this creates a synthetic put option). The reason you would buy out of the money calls is because they are relatively inexpensive (remember there is a cost to protect these positions in the call premium you pay). See this article for more color on a protective call.
So, what I did was look at all the open call interest on TSLA (as of 4/19/2013) on all strike prices for all the available months which are: May, June, September, January 2014 and January 2015. The total call option open interest in all of those available months is 108,471 contracts (approximately 20,000 of which were purchased on Friday). Therefore, if every single one of those call options were owned by shorts they would have 108,471 * 100 (shares per contract) = 10,847,100 shares of potential ownership. Remember there are 31 million shares currently short. Therefore, if every call option in TSLA was owned by a TSLA short as hedges shorts would have hedged ONLY about 1/3 of their short TSLA position. However, we know that all the call options are not owned only by short sellers. There is no way to know exactly how many of the call options are owned by shorts or just pure call buyers, but I will take a shot at estimating this in a conservative fashion.
First, I find it unlikely that many shorts would have hedged their short positions with January 2015 call options as the premium cost of those would really not make much sense as a hedge for a short in my opinion. Therefore, I am eliminating all the call options open in January 2015 (that is 7,090 contracts) as being used by shorts to hedge. Next, since TSLA has traded pretty much above $30 a share for the last six months I find it unlikely many shorts are hedged using strike prices less than $30. However, there are very few call contracts outstanding under $30 (956 contacts in total for all months available, of which 394 are in January 2015), so I will just leave them in my "available pool" of call options shorts might own. Additionally, it is questionable that shorts would be using many January 2014 calls which would be pretty costly to use as a hedge (of which there are 33,974 contracts outstanding), however, again I will leave those contracts in the available pool just to be conservative. One could easily remove those from the available pool and be considered reasonable.
So finally I took the total outstanding contracts from all strike prices and all the months available from above of 108,471 less the January 2015 contracts of 7,090 and I get a possible pool of options where shorts may be long calls of 101,381 contracts (let's call this number the "Available Pool"). Again, I think this is conservative and it is quite likely the pool is much smaller. Next comes the harder assumption, how many call options in the Available Pool are owned by shorts versus pure long buyers. Therefore, I will do three scenarios below:
Scenario #1: Assuming shorts own 75% of the Available Pool that would be: 75% x 101,381 call contracts x 100 shares per contract = 7,603,575 shares possibly hedged by shorts. If this were the case, shorts would have hedged 7,603,757 shares / 31,300,039 shares short = only 24.3% of shares sold short would be hedged.
Scenario #2: Assuming shorts own 50% of the Available Pool that would be: 50% x 101,381 call contracts x 100 shares per contract = 5,069,050 shares possibly hedged by shorts. If this were the case, shorts would have hedged 5,069,050 shares / 31,300,039 shares short = only 16.2% of shares sold short would be hedged.
Scenario #3: Assuming shorts own 25% of the Available Pool that would be: 25% x 101,381 call contracts x 100 shares per contract = 2,534,515 shares possibly hedged by shorts. If this were the case, shorts would have hedged 2,534,535 shares / 31,300,039 shares short = only 8.1% of shares sold short would be hedged.
Therefore, no matter which scenario you pick shorts are NOT very hedged through the use of call options in TSLA. At best, shorts may have approximately 25% of the shares sold short hedged which still leaves 23,696,464 unhedged short sales based on my analysis (31,300,039 shares short less 7,603,757 shares possibly hedged in Scenario #1). If 23,696,464 shares are unhedged shorts, then that would still be an enormous 36% of the float sold short (unhedged).
What this all means is shorts are in a very vulnerable position to get setup for an epic short squeeze if any or all of the likely upcoming catalysts come through:
1. Earnings and guidance are favorable for the next month when people start to really understand the potential of this story. The CEO has already announced that he expects TSLA to have its first quarter of GAAP and non-GAAP profitability upcoming. If TSLA can make money with less than 5,000 cars sold in a quarter, what can they do if TSLA really gets traction over the longer term? This is a quarter that potentially puts TSLA on the map for growth fund investors as a viable way to play the future of the auto business (and TSLA becomes the pure play on this in the public markets). Additionally, there have been rumors that production may be running above previous estimates (see article here).
2. News flow continues to be positive. The CEO has promised news flow upcoming (see Bloomberg interview) every couple of weeks.
3. TSLA has been mostly a US story so far, but it is beginning to launch in other geographies (Europe/Asia). This is a possible upside driver not currently in the analyst numbers.
4. More and more people are starting to look at CEO Elon Musk as the potential new "Steve Jobs". For instance he is on the upcoming cover of TIME magazine. This impression should not hurt the interest for TSLA stock.
5. Finally, one catalyst could be that either after earnings or before, analysts become very bullish on TSLA. While some analysts like TSLA, none of them have really gone "all-in" on the long term story yet. This may be about to change.
Disclosure: I am long TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.