Tesla Price Volatility Presents Opportunities Via Short-Term ETP Plays

Summary

• TSLA's histrionic stock trajectory makes the prospect of short-term leveraged play via ETPs highly viable.
• Given the existence of leveraged single-stock ETPs, the question of whether to go higher or lower in factor makes trend estimation quite important.
• In the absence of a "snap back" after a drop, the loss in leveraged investment value is very dramatic.
• The "snap back" has become an increasingly-recurrent feature in major stocks in recent times.

Jira Pliankharom/iStock via Getty Images

Recent coverage of Tesla, Inc (TSLA) contended that while the company's future is expected to be good, it isn't altogether unsound for active investors to use ETPs for short-term gains during the stock's swings.

Short-term plays are typically made in an investor's "satellite" portfolio. Regardless of whether the company's stock is present in an investor's "core" portfolio or not, the stock's current price volatility heightens the use case for investments into leveraged single-stock ETPs in the "satellite" ("core" and "satellite" portfolios were discussed in an earlier article).

For investors coming to grips with investing in ETPs ("exchange-traded products"), they might have difficulty in deciding between two leverage factors, say 2X and 3X. When in doubt, do they go big (i.e., 3X) or stay moderate (i.e., 2X)? Well, it all depends. This article will take apart what it means to have a “trend” in the underlying and how deeply it affects an investor’s "satellite" portfolio value using the aforementioned leverage factors. The arguments presented can also be extended outwards, i.e. in deciding between 3X or 4X, 4X or 5X, and so forth.

A few notes right at the outset:

• In practitioners' parlance, ETPs are very distinctive from ETFs. The latter feature quite heavily in retirement accounts but the former are predominantly deployed by sophisticated tactical investors. For a clear delineation in terms and landscape, click here to read a comprehensive summary.
• This article makes comparisons using single-stock ETP data versus the stock's. While the latter is publicly-available in most parts of the world, the former is usually available via some data vendors for a recurring fee or made available to investors by specific brokers who have onboarded these products. Leverage Shares' ETP data has been used in this article for a simple reason: I work there and am permitted to use this data for some articles. There are, of course, other ETP issuers; readers are advised to enquire with their preferred brokers to determine which ones are available in their region for analysis.
• Unlike ETFs, ETPs vary highly by issuer with respect to construction and fees. The complexity frequently confuses even brokers who conflate them with structured products (which they aren't). Since Leverage Shares' data is used, a comprehensive outline of the company's specific flavour of ETPs in terms of features, value proposition relative to popular structured products and things to keep in mind when investing in these products has been made available (click here to read the first part of seven, which discusses these matters in exacting detail).

Broadly speaking, when it comes to any leveraged single-stock ETP, “the trend is your friend.”

Leveraged Plays

First, a number of cases for "long" price performance plays will be presented. The products used for analysis will be two of the company's long-standing crowd-favourites: the US$-denominated 2X Tesla ETP (TSL2) and the 3X Tesla ETP (TSL3). These products' performance will be compared against that of the underlying stock, TSLA.

The Case for 3X

Let’s hypothetically “invest” into the three products – TSLA, TSL2 and TSL3 – on the 29^th of December 2020. Over the next 8 trading days, TSLA skyrockets over 32% in value, with not a single day of a “snap back”.

The stock shows a relatively weak upward trend until the 5^th, after which there's a big jump upwards till the 8^th. Both TSL2 and TSL3 show a corresponding trend across the period, climbing in value by 75% and 121%, respectively.

This case demonstrates:

If the underlying ends up climbing day-on-day, a higher leverage factor is a better bet to make than a lower leverage factor

But readers should note that hindsight is always 20-20. When this is not the case, making a choice gets a little more complex.

The Case for 2X

Let’s hypothetically “invest” into the same three products on the 29^th of July 2020. Over the next 11 trading days, TSLA has a modest net climb (by its standards) of 3.7%. However, between these days, TSLA’s trajectory is anything but modest. The stock sees a drop of 5% by the 31^st and a meandering recovery until the 11^th, which precedes a dramatic 13% spike, to end up with an overall rise of 3.7%. Both TSL2 and TSL3 show a corresponding trend across the period, climbing in value by 5.4% and 5.9%, respectively:

Until the 11^th, the value of a 2X investment is clearly evident: the 3X doesn’t really recover lost ground after the 15% drop in value by the 31^st, while the 2X meandered closer to the underlying after the 31^st until the 11^th. The 13% spike on the 12^th finally enabled the 3X to draw up nearly par with the 2X.

Another more recent case of a similar nature further exemplifies this behaviour: let’s hypothetically “invest” into the three products on the 4^th of March 2021. Over the next 5 trading days, TSLA climbs up 7.5%. However, between these days, TSLA’s trajectory is – like in the previous case – rather dramatic. The stock drops by 9.4% by the 8^th, does a sharp recovery of nearly 20% the next day and then has a slight fall of under 1% the day after that. Both TSL2 and TSL3 show a corresponding trend across the period, climbing in value by 11.8% and 13.1%, respectively:

Like in the previous scenario, the value of the 2X investment is clearly visible: while the 3X had lost nearly 27% of its value by the 8^th, the 2X and the underlying and the 2X had lost 9.4% and 18.4%, respectively. In fact, the drop is so profound that even the single-day 20% increase in the underlying only gives the 3X a 2.5% edge in gains over the 2X, which now has a net gain of almost 14%.

Inverse/Leveraged Inverse Plays

Now, a number of cases for "short" price performance plays will be presented. The products used for analysis will be two of the company's newer products that have seen increasing AUM: the US$-denominated -2X Short Tesla ETP (TS2S) and the -3X Short Tesla ETP (TS3S). As before, these products' performance will be compared against that of the underlying stock, TSLA.

The Case for (Short) 3X

Let’s hypothetically “invest” into the three products on the 1^st of November 2021. Over the next 9 trading days, TSLA, after some price discovery action until the 5^th goes on to have a dramatic net drop of 16.2%, with not a single day of a “snap back” from the 5^th onwards. Both TS2S and TS3S show a corresponding inverse trend across the period, climbing in value by 33% and 49%, respectively.

The inversion of the play does not invalidate the lesson learnt in the 3X “Leveraged Play” use case when it comes to leverage factor.

As expected, in the event of a “snap back”, the choice of factor for play becomes a little more complex.

The Case for (Short) 2X

Let’s hypothetically “invest” into the three products on the 10^th of September 2021. Over the next 7 trading days, TSLA has a modest net drop of 0.8%. However, between these days, the stock sees a rise culminating to net -3.2% by the 17^th and a dramatic 3.9% recovery the next day. Both TS2S and TS3S show a corresponding inverse trend across the period, dropping in value by 6.1% and 9.3% respectively before drawing up about par with each other and about 1% above the stock:

Another instance clarifies this behaviour and mirrors the lesson learnt in the 2X “Leveraged Play” use case: let’s hypothetically “invest” into the three products on the 15^th of March 2021. Over the next 12 trading days, TSLA drops by a net 4%. However, between these days, TSLA’s trajectory sees some price discovery action around par until a dramatic drop by a net 8.4% on the 29^th followed by 4.8% recovery the next day. Both TS2S and TS3S show a corresponding trend across the period, climbing in value by 17% and 25% before closing at least 9% above the stock, with TS3S ahead by about 1.3%:

In Conclusion

By examining the behaviour of the 3X and 2X across scenarios (both leveraged and inverse/leveraged inverse), a generalized argument on the choice of leverage factor can be summarized thus:

When it comes to choppy markets, a lower leverage factor has a significantly-less pronounced value decay than a higher leverage factor

It also bears noting in the scenarios described in the case made for 2X, there was one single day where the underlying has a “snap back” in trend. This illustrates the damaging effects of “value decay”: the 3X just about drew par with the 2X after several days of value loss that was greater than that seen in the 2X. Thus, the 2X investment was the better choice to make a bet simply because it lost less value than the 3X and ended up par with the 3X after trend recovery.

Long-time investors would know that Tesla's dramatic “snap backs” are certainly not strange for the stock. Since the time period presented in the "Inverse 3X" scenario, the company has seen a surge in turnover for 3X Tesla ETP, which suggests that tactical investors are anticipating a “snap back” towards a bullish trend. However, relative to past volumes, this is true for 3X (Short) Tesla ETPs as well. In overall positions, however, while the former is far greater than the latter, the complications the company faces as suggested in the stock's trajectory (and mentioned in the recent coverage) are beginning to loom large in investor strategies.

None of the aforementioned plays are recommended as long-term strategies (although an investor can choose to hold on to a 2X/3X Long/Short Tesla ETP for as long as said ETP exists). As seen in the examples, it's not quite the same as doubling down on a fractional investment/short; buying the 2X ETP can, for example, deliver far greater or less than 2X in gains over a time horizon. Trends in the underlying determine what this value is going to be.

“Choppy market” scenarios, which are quite frequent with Tesla at least partially due to the outsized "meme" interest in it, are also beginning to manifest themselves more regularly in the trajectories of almost every ‘popular’ stock lately.

Going by the numbers seen in ETP adoption over the YTD, it seems that an increasing number of investors recognize the fact that holding on to a stock in a "core" portfolio for ages might work out eventually, but there's no point in being evangelical regarding their stock picks and leave money on the table by not investing in short-term plays. For these investors, investing into and actively managing these kinds of products add the potential for securing magnified returns based on their analysis of market sentiment.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Leverage Shares is an exchange-traded products issuer that offers daily-rebalanced products in leveraged/unleveraged/inverse/inverse leveraged factors. The company holds both long and short positions in a number of stocks, including those mentioned in this article, in order to construct the products offered to investors. Please consider risk factors carefully before investing in these products.