Options Prices Imply A Bearish Outlook For Tesla

Apr. 15, 2021 6:06 PM ETTesla, Inc. (TSLA)146 Comments20 Likes
Geoff Considine profile picture
Geoff Considine
4.94K Followers

Summary

  • TSLA's valuation is sensitive to assumptions about earnings growth, as well as interest rates.
  • There is enormous dispersion in the Wall Street analysts' price targets due to this sensitivity.
  • The Wall Street analyst consensus is that the stock is overpriced.
  • The market-implied outlook (derived from options prices) gives probabilities tilted to price declines to early 2022.
  • My overall rating is bearish.

Tesla Service Center. Tesla designs and manufactures the Model S electric sedan IV
Photo by jetcityimage/iStock Editorial via Getty Images

Tesla (NASDAQ:TSLA) has a trailing twelve-month P/E of 1,226 (Source: eTrade) and a forward P/E of 180 (Source: Seeking Alpha). At these levels of P/E ratio, the vast majority of Tesla’s valuation depends on earnings growth, as with other fast-growing companies. It is not surprising that TSLA stock dropped substantially during concerns about rising rates in early 2021. Companies for which the valuations depend on future rapid earnings growth will tend to be very sensitive to rates, because rising rates increase the discount rate applied to future earnings and the impact of this increase is much higher for earnings further into the future. Especially in cases in which a stock’s value is sensitive to justifiably variable assumptions about future earnings, considering a range of possible outcomes is important. Put in statistical terms, systems with low predictability are best analyzed using ensemble forecasts rather than point forecasts.

Price history and basic statistics for TSLA (Source: Seeking Alpha)

My approach to equity analysis is from a statistical standpoint rather than bottom-up fundamental valuation. I can offer no unique insight into Tesla’s technology, how quickly Tesla will grow its sales or as to the impact of competition from other car manufacturers. If you are looking for one more equity analyst’s opinion, this article is not for you. In this article, I compare two different consensus outlooks for the stock. The first is the consensus rating and price target from the Wall Street equity analysts who follow the company. The second consensus view is the market-implied outlook which is derived from the prices at which options are trading. This is, in effect, the consensus opinion of all of the buyers and sellers of options on TSLA. Market-implied outlooks are quite common in quantitative finance but tend to be less familiar to investors and advisors. I have written an overview post that provides examples and links to the finance literature and an implementation of market-implied outlooks by the Minneapolis Federal Reserve Bank.

Wall Street Analyst Ratings

Especially for a company like Tesla, which is innovating and evolving rapidly in a market that is also growing and changing quickly, the consensus outlook of equity analysts is of interest. Each analyst will apply their own assumptions and estimates, and the consensus will tend to emphasize the common aspects and damp out the outliers. In addition, the dispersion among the analysts provides a sense of uncertainty. The higher the dispersion among price targets, for example, the less predictive the consensus target tends to be.

eTrade’s calculation of the Wall Street consensus combines the view of 27 ranked analysts who have rated the stock and provided 12-month price targets over the past 90 days. The consensus rating is neutral (HOLD) and the consensus 12-month price target is 6.5% below the current share price. The spread in the price targets is enormous, with the highest price target almost 8.9 times the lowest price target. The lowest 12-month target, $135, is not an extreme outlier. There are also analysts with price targets of $150 and $180 as well as three analysts with price targets between $200 and $300.

Wall Street analyst consensus rating and 12-month price target for TSLA (Source: eTrade)

Seeking Alpha’s calculation for the Wall Street consensus combines the outlooks of 35 analysts. The consensus rating is neutral, with a price target of $636.47, which is 15% below the current price.

Wall Street analyst consensus rating and price target for TSLA (Source: Seeking Alpha)

The wide range of analyst opinions is also captured in the pie chart of ratings. There are 14 analysts with bullish ratings, 13 with neutral ratings, and 8 with bearish ratings.

Market-Implied Outlook

The buyers and sellers of options on TSLA are placing bets on the probabilities of the price rising above (call options) or falling below (put options) a specific price (the strike price) between now and the expiration date of the options. By combining the prices of call options and put options at a range of strikes and the same expiration date, it is possible to calculate the probability distribution of price returns (between now and the expiration date) that reconcile all of the options prices. This probabilistic outlook for price returns is referred to as the market-implied (aka option-implied) outlook and represents the consensus outlook of the options market. The market-implied outlook provides an interesting complement to the Wall Street analyst outlook.

I have analyzed options on TSLA that expire on January 21, 2022 to provide the market-implied outlook for the next 9.25 months (between now and that date). The market-implied outlook is charted in the form of a standard probability distribution of returns, with probability on the vertical axis and price return on the horizontal axis, going from most negative on the left to most positive on the right.

Market-implied price return probabilities for TSLA for the period from today until January 21, 2022 (Source: author’s calculations using options quotes from eTrade)

What is immediately obvious in the market-implied outlook for the next 9.25 months is the very high positive skewness in returns. The single most-probable price return over this period is -34% and the median return is -18% (There is equal probability of being above or below the median). There is, however, an extremely long positive tail on the distribution, such that there is a low but meaningful probability of exceedingly high returns. This is a bearish outlook, with the most probable outcomes being substantially negative price returns over the next 9.25 months.

The annualized volatility of TSLA derived from this distribution is 69%, which is very high for a large cap or mid cap stock. To put this in context, I recently calculated 62% annualized volatility for Snowflake (SNOW) using the same type of analysis.

In my analyses using the market-implied outlook, I often rotate the negative return side of the distribution about the vertical axis in order to make it easier to see the relative probabilities of positive and negative returns of the same magnitude (see chart below). I provide this view to make it easier to compare the market-implied outlook for TSLA to some of my other analysis.

Market-implied price return probabilities for TSLA for the period from today until January 21, 2022 and with the negative return side of the chart rotated about the vertical axis (Source: author’s calculations using options quotes from eTrade)

This chart looks very similar to the market-implied outlook for Teladoc from February, for example. I have been seeing this form of market-implied outlook for a range of tech stocks in recent months. The common characteristics are high positive skewness and prevailing probabilities tilted to price declines.

Another view of the market-implied outlook is in terms of the percentiles of the outcomes (this is referred to as the cumulative probability distribution). The percentiles show the probability of having a return above or below a specific level (see chart below).

Percentiles of market-implied price return probabilities for TSLA for the period from today until January 21, 2022 (Source: author’s calculations using options quotes from eTrade)

There is a 64% probability of having a price return less than or equal to zero for the 9.25 month period (where the percentile curve crosses zero return). The skewness effect is easy to see here. The 20th percentile return is -44%, which means that there is a 20% probability of having a price return of -44% or worse over the next 9.25 months. The 10th percentile is -59%. The 80th percentile is +47% and the 90th percentile is +88%. The extreme percentiles illustrate the skewness. There is a 10% probability of having returns less than or equal to -59% (the 10th percentile) and there is a 10% chance of having a return greater than +88% (the 90th percentile).

There is a very active options market on TSLA, so the market-implied outlook is of considerable interest. The consensus outlook of the options traders suggests that the highest-probability outcomes over the next 9.25 months are price declines, a bearish view. There is also an elevated potential, albeit with low probability, for out-sized positive returns.

Summary

Tesla is a remarkable company that has transformed and continues to lead the market for electric vehicles. Because the technology, the business, and the policy and regulation around electric vehicles is evolving so quickly, I believe it is especially important to analyze TSLA by looking at the range of forecasts. The Wall Street consensus provides one approach to capturing uncertainty by looking at the dispersion in price targets. The market-implied outlook provides a particularly relevant probabilistic outlook. The Wall Street consensus is that TSLA is currently overpriced, with a consensus 12-month price target implying a return of -6.5% to -15%. The dispersion in analyst price targets is enormous, varying by a factor of 9X. The market-implied outlook gives a median price return of -18%, with the single most-probable price return (the mode of the distribution) equal to -34%, for the next 9.25 months. The annualized volatility derived from the market-implied outlook is 69%. My final rating is bearish. There is the potential for enormous positive returns, but the prevailing odds point towards price declines.

This article was written by

Geoff Considine profile picture
4.94K Followers
Geoff has worked in quantitative finance for more than twenty years. Before entering finance, Geoff was a research scientist for NASA. Geoff holds a PhD in Atmospheric Science from the University of Colorado - Boulder and a BS in Physics from Georgia Tech. Neither Geoff Considine nor Quantext (Geoff's company) are investment advisors. Nothing in any commentary here on Seeking Alpha or elsewhere shall be regarded as advice.
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Disclosure: I/we 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.

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