Tesla Requires Patience And Options

| About: Tesla Motors (TSLA)

When looking at growth stocks trading at a high P/E, one must speculate and invest with caution. When speculating or investing in Tesla (NASDAQ:TSLA) one must consider the electric car and its future in the automobile industry. The price of Tesla shares have increased in recent months as shown on the chart below, and there are a wide range of investors holding shares at different entry points. Different average costs per share means a variety of different strategies must be adopted. The chart below shows stock prices over the last 3 months. The fast run-up in the price means that there are some happy investors at a cost at less than half of the current market price, while others who have purchased shares at current market prices may experience financial loss should the price depreciate. Depending on when one took a position in Tesla, there are different options strategies one could utilize to either hedge out some risk, and/or generate some income.

TSLA 3 month chart

Placing investment strategy aside, when you consider the company and the future of the automobile industry there are a variety of opinions about the viability of the current price of the stock. If a complete shift in consumer preferences over time occurs, and the concept of the electric car becomes the standard in new automobile purchases, then Tesla is going to be the company that changed the way we think about driving. They are the first company that is redefining a century long industry paradigm and producing electronic cars that can actually compete with gas powered cars, while also being cool to drive. Tesla's manufacturing efficiency, supply chain logistics, and overall engineering processes are undoubtedly top notch and Tesla is arguably the most efficient car manufacturer. Tesla is gaining economies of scale, and eventually will be producing cars at a lower price point. The company will offer competitive financing and sell to a wider range of consumers who can afford a mid priced electric car. From a business perspective the future looks great with excellent prospects. Tesla will either grow organically and show steady quarterly EPS increases and/or be bought out. The other side of the coin is that other car manufacturers will compete and Tesla will not generate sufficient earnings to justify triple digit stock prices.

That considered, one must separate the business from the stock. Ben Graham and later Warren Buffett taught that there is no such thing as a good or a bad stock it is only cheap or expensive. At a $100 stock price, there is potential for significant upside and downside volatility. You do not want to be caught in large price swings.

If everything goes as planned and a shift in paradigm occurs Tesla will either be bought out and investors will be well compensated, or Tesla will continue to grow earnings and after repeated quarterly earnings increases the shares will appreciate. If you believe in the viability of the above strategy then you should be prepared for volatility working for and against your position.

Here Are Different Strategies for Different Entry Points:

Recently Accumulated Stock (around $100 per share)

If the stock goes down 20% to $80 per share it will still have doubled in 2013, but you will be facing a 20% loss. Some strategies to incorporate are as follows:

  1. Typically setting a stop loss at a price to protect yourself from a complete collapse in the price of the stock is sometimes a good strategy. If you are worried about losing a significant sum of money setting a stop loss at a price that makes you comfortable may be a good strategy. I recommend not setting the stop loss at an even number as a stop price of $90 will be triggered more often than a price of $89.85.

  2. Average down/up: if you are a long-term holder and have just started accumulating a position every two weeks, month, or whatever cycle works for you to buy stock at current market prices. If the stock goes up you will have more shares at an average price still showing a profit. If the stock goes down you can buy shares cheaper lowering your average cost per share.

  3. Covered Call or Writing Put Options: If you want to generate some income as you wait for Tesla to deliver either writing covered calls, or writing puts will enable you to generate income after each expiration of the options. These two strategies are ideal if the stock stays in a narrow band and allows you to collect the premiums.

If you are worried about stock price going down: = covered calls

If you are worried about the price going up: = write put options

Both of these strategies will enable you to receive income by taking in the premiums every month or whenever the contracts expire.

Previously Accumulated Stock (around $70 per share)

  1. Buying Puts: Especially beneficial for those who have significant gains on shares already purchased at lower price points. Buying put options allows you to profit if the price of the stock goes down, thus you can obtain arbitrage on the position by leveraging your already profitable share position.

If you are uncomfortable with the math of options and trading with options, there are mobile phone applications you can download that allow you to simulate trading stocks with options with the strategies mentioned above. These apps are normally paid apps ranging in price but you can typically find them for less than $10.

If you purchased 300 shares of Tesla at $65 at a cost of $19,500 and the price per share is $100 you have profited $10,500 on the trade. If you wanted to make sure that you didn't lose money if the price of Tesla shares fell back to $65 and wanted to protect yourself against a downward move in the stock from now until the third week in July, you could purchase 3x $95 put options for $7.50. By utilizing this strategy you would stand to profit $6,750 if the price of the stock were to fall to any price below $95. Using this strategy the price could go back to $65 and you would still profit as opposed to breaking even. Mobile applications such as stock protector will actually tell you what put options you need to hedge out risk. Using this strategy allows you to make money if the price of Tesla goes higher or lower.

The above simulations and other options strategies might be the key in making sure you don't suffer a large loss. The financial data below shows progress in increased earnings, however if this pace were to slow, investors may experience large fast swings in the price as the fundamentals are not what is supporting a $100 stock price.

Looking at the operating income of $ -5.58 compared to that of $-90.89 and $-108.46 in the preceding quarters shows that Tesla's operating income is steadily improving and the road to profitability is around the corner. See the below chart courtesy of Google finance.

Click to enlarge

In the current market environment where large swings in prices are to be expected, a prudent investor should analyze different options strategies to limit the risk they have and to make sure that large price swings in Tesla works for and not against them.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.