A Statistical Trade For Tesla's Battery Day Event

Summary

• There is plenty of hype around Tesla's battery day, schedule for Tuesday September 22nd.
• I run a simulation aimed at highlighting the chances for both bulls and bears to make a profit trading the stock short term.
• While the probabilities are showing a bigger upside potential, historical returns are only an indication of the future, and it all will ultimately depend on the outcome of the presentation.

Introduction

Tesla (TSLA)’s 2020 battery day is approaching, and CEO Elon Musk has helped to build the hype with strong statements such as “it will blow your mind” during the last earnings call. A statement of that kind is likely to have drawn your attention just as it did with mine, and it has probably left you wondering whether a trading opportunity will arise from the event revelations. Tesla is a very volatile stock, and we will probably experience an increase in trading activity in the days and weeks following the event, with the stock soaring or bursting depending on the result. For those willing to try and capture the upside or downside following the event, I outline two trading strategies based on a statistical analysis of returns.

Source

A History of Revelations

In 2016, Elon Musk presented the solar roof, after proposing what he referred to as a “no-brainer” acquisition. The event helped convincing shareholder to approve the acquisition of SolarCity for $2.6 billion. At autonomy day in April 2019, Musk and his engineering team presented the robotaxi technology, and the CEO expressed his expectation to have the first operating robotaxis in 2020. Most recently, the November 2019 CyberTruck presentation also induced high stock volatility, with the stock tanking after hours before rebounding over the following days.

Figure 1

Source: Author/ Yahoo Finance

Despite the success or failure of these demonstrations, Tesla events often lead to short-term stock volatility. In this case, the high expectation could cause additional turmoil, as the bear and bull camps are pretty divided. CNBC's Jim Cramer expects battery day to be a disappointment for Tesla stock, while several analysts increased their target price ahead of the event:

- UBS doubled from $160 to $325;

- Wedbush PT increased from $380 to $475;

- Deutsche Bank from $300 to $400;

- Credit Suisse from $280 to $400.

However, If Tesla doesn't reveal cutting edge advancements at the event, the high expectations will put even more downward pressure on the stock. Trying to capture some of this volatility, I outline two short-term trading strategies based on a Monte Carlo simulation.

Statistical Analysis

Taking Tesla stock price returns since inception, I simulated 1000 random trials of dependent, standardized stock residuals over a 1-week and a 1-month time horizon.*

Figure 2 - 1-Week Simulation

Figure 3 - 1-Month Simulation

Source: Author Calculations

The simulation leads at the following results:

Over a 1-week time horizon:

Max Simulated Gain: 96.5%

Max Simulated Loss: 33.7%

Over a 1-month time horizon:

Max Simulated Gain: 134.2%

Max Simulated Loss: 61.6%

Simulated 90% VaR: 16.3% - $370

Simulated 99% VaR: 41.47% - $259

Based on the statistical results over the 1-month period, we can formulate two trading strategy depending on whether you own the stock or not.

From today’s $442 price, a bullish strategy for a stock owner could yield significant profit. If you own 100 shares of Tesla stock, there is a 91% simulated chance that the stock would trade under $540 in a month time. At the same time, there is a 90% chance that the stock would remain above $370. The strategy consists of collar option combo, buying a put option with strike $370 (priced $31.1, Oct-23) and selling a covered call with strike $540 (priced at $38.5, Oct-23). The strategy would limit your downside at 14% should the event go terribly bad for Tesla, cap your upside at a 24% gain should it go extremely well (with 90% chance of your shares not getting called away), and pocket you 740$ should the event bring about no volatility.

On the other hand, should you not own the stock, but want to own it at a way cheaper price, you can base your strategy on the 99% VaR (Value at Risk). If you are not familiar with the metric, the 99% VaR means there is a 99% probability that the price of the stock won’t drop below 259$ (-41.47%). A put option with strike $250 can be sold to pocket $500 (expiry oct-23) and will allow you to own 100 shares at a 40% discount should the stock drop to that level. I’m talking about covered put, I do not advise naked selling. In fact, the simulation is partially based on historical returns, and it’s easy to imagine how the stock recent bullish run would skew the results to the upside.

The being said, a strategy for the bears. Given the 90% chance of the stock remaining above $370, the best strategy may be buying a put spread with strike 440 – 370. The spread currently would cost around $4000 (67-26.25=40.75, expiry 23-oct), for a potential gross profit of $7000. Based on the simulation, such a strategy would result in a positive net profit only with a 20% probability. But who knows, given the negative streak for Tesla bears, this could finally be the winning time.

Bottom Line

The history of Tesla events suggests significant volatility after Battery day. I run a simulation aimed at highlighting the chances for both bull and bear to make a profit trading the stock short term. While the probabilities are showing a bigger upside potential, historical returns are only an indication of the future, and it all will ultimately depend on the actual outcome of Elon Musk’s presentation.

*Note: the Monte Carlo simulation is based on historical return using a Student's t copula, dependent on the SPY returns (which may dampen volatility), using the canonical maximum likelihood(CML) calibration method. Feel free to contact me for additional information.

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