The Tesla (NASDAQ:TSLA) story has been extremely well chronicled as the stock has exploded higher over the last 90 days. In early March, Tesla traded for close to $35 a share. As of May 29th, the stock has seen nearly a 200% gain to breach the $100 a share level. Through a bevy of quasi positive announcements, market moving tweets, analyst upgrades, and a general Elon Musk risk-on trade, the stock is on a run that is nothing short of breathtaking. This is a case where trying to provide analysis or reasoning for why the stock spiked 200% is almost fruitless. Investors need to accept that, at times, the stock market acts without regard for reason. The move higher in the shares of Tesla should probably be considered one of those times. Nothing that Tesla has done in the last 90 days justifies the market cap of the company increasing from $4B to $12B. About the only guarantee from the events of the last 30 days, is that Tesla is going to be in business for awhile after shoring up the balance sheet by tapping the capital markets with a secondary offering to the tune of $1B. Other than that, the same risks that existed 90 days ago exist today.
The same arguments about the future of Tesla, and the potential competition from Ford (NYSE:F), General Motors (NYSE:GM), and Nissan (OTCPK:NSANY) are still valid. Is there any rationale argument why Tesla has 1/5th the valuation of Ford, yet has revenue estimates for 2013 that are only 1/100th of the revenue estimate for Ford? Absolutely not, but shorting the stock has proved futile over the last 200% move higher supporting the assertion that there is nothing that says the trend should reverse now. Conversely, the valuation today is clearly at nosebleed levels with investors betting the farm on the probability of a level of success that could only materialize years in the future. Is it just this dynamic, between the bullish and bearish arguments that can allow investors to take advantage of the two extremes to generate income in the short term.
The Tesla Trade
With the underlying volatility in Tesla options exploding higher with the share price, investors have the ability to take advantage of this dynamic to generate an income stream through selling put options. Consider the current situation for Tesla. If you buy the stock outright, you're buying a stock that has run up 200% in the last 90 days, where further upside in the near term is hard to rationalize. If you are in the camp that the stock has to fall, and you want to short the stock, there is a good chance you had the same opinion when the stock moved from $35 a share to $70 a share. The point being, the risk of outright shorting this stock with unlimited potential losses does not make for a sound investment, regardless of perceived valuation at this time.
I intend to take advantage of the situation and sell out of the money put options, capturing the volatility that exists today in Tesla and attempting to profit from it. The trade I intend to enter is to sell the January 2014, $60 put options which are trading for about $4.60 as of May 29th. As an example, I can sell 1 contract, with that contract representing 100 shares of the common stock. I would receive $460 in proceeds before factoring in trading commissions (100 shares x $4.60). My effective investment would be $6,000 as I am committing to owning shares of Tesla if they happen to fall below $60 per share by January 2014. If the shares fell below $60 by the time the options expired, I would be required to buy 100 shares at $60 a share, to satisfy the put options that I sold.
I like this trade for a number of reasons. First and foremost, the risk profile of the trade is favorable in my opinion. Tesla would have to fall over 40% from its current price over the next 7.5 months before this could be a money losing trade. With the secondary offering and the cash raised by Tesla, the valuation floor for the stock is now significantly higher than it was prior to the 200% jump higher from $35 a share. The second reason I like this trade is for the yield and income stream that it would generate. Earning $460 while having $6,000 at risk, equates to a potential gain of a little over 7.5% in less than 8 months. When you annualize this gain, it equates to about an 11.5% gain before commissions and taxes. As an investor, I am very much in favor of hitting a bunch of singles then trying to hit a home-run with each investment I make. Buying Tesla, either through an outright long position or short position, is effectively trying to hit a home run. The measured approach I offered above and intend to use, allows the stock to go down 40% before my investment is potentially a money loser.
I think all small investors who desire to get in on the action in Tesla would be wise to let the big boys slug it out in search of another 40% move over the next 8 moths, in either direction. My approach will be to sit back, and be perfectly content hitting a single that yields an 11%+ annualized return while watching the fireworks knowing I have a comfortable margin of error built into my investment.
Additional disclosure: Potential long position would be through selling put options as described in the article.