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Thoughts On Call Option Trading In Tesla

Jul. 16, 2020 1:31 PM ETTesla, Inc. (TSLA)1 Comment
Ruerd Heeg profile picture
Ruerd Heeg's Blog
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In the last 3-4 days there were several rumors related to excessive inventory build at Tesla (TSLA). See for example this tweet, and here. I do not think it is a coincidence that there are rumors Tesla will shut down part of Fremont "for retooling". I think the rumor says Tesla will shut down the production lines for model 3 and model Y in the tents.

Meanwhile Tesla is being sued for not paying rent. How much cash did they report? 8 billion? In any case this is not what people expect of a public company with a market cap of more than $250 billion.

But it is what can be expected from car manufacturers building cars that cannot be sold. See this story about model Y demand. Inventory building takes up a lot of cash. Some of the inventory building can be financed with loans, but not everything. At some point Tesla does not have enough money anymore to continue to invest in car inventory it cannot sell. Hence the rumors related to the closure of some production lines in Fremont. BTW, there was a similar closure of Shanghai production some time ago.

So with all this financial distress why is the share price still so high? It seems certain investors buy weekly out of the money call options on a massive scale. See for example here. Market makers have to hedge these call options with long positions in Tesla. Before the call options are bought the call buyer sets up a regular long position. With proper timing the purchases of calls lift up the stock price up more than the costs of the calls. The long position can usually sold for a profit exceeding the costs of the call options even if they expire worthless. See also here. And here for the opinion of short seller Jim Chanos.

There are 2 questions here. The first is whether this trading is legal. The second question is who is doing this.

Is this call options scheme legal?

I think it should be illegal because buying these call options do not seem to have any other economic benefit than artificially lifting the stock price. They are so much out of the money that in practice it is extremely unlikely they can be exercised for a profit. I have read stories about people being punished for trying to set closing prices by trading illiquid stocks between different accounts of their own. I think this is similar: transactions that economically do not make sense are used to set closing prices for paper profits. But on the other hand Porsche did something similar in 2008. This resulted in a squeeze of Volkswagen short sellers. Porsche executives were sued but were acquitted because bad intent could not be proven in court. Specifically bad intent could not be proven because Porsche really had plans to acquire Volkswagen. See here.

Who is doing this?

It is possible hedge funds or other institutions are doing this. But then I wonder why they are not also doing the opposite with short selling combined with out of the money weekly put options. Also I suppose hedge funds might be repelled to do this in either direction because of the legal risks. So I think it is unlikely hedge funds or other institutions are doing this but we cannot rule it out.

In theory it is also possible (several thousands of) retail investors are doing this. But since it involves spending millions of dollars every week I suppose such a coordinated pump cannot be kept silent. We would have heard about it on social media like Twitter and Facebook. So I think it is very unlikely retail investors are doing this.

Insiders certainly have a good motive for doing this: director and executive option compensation. They like high stock prices so they would not be doing the opposite with short positions and put options. A high stock price also makes it easier to raise new equity which prevents Tesla from going bankrupt.

There are 2 insiders with enough money to do this: Elon Musk and Larry Ellison. With his generous equity compensation plan Musk has by far the best incentives for doing this. I also find it very suspicious Musk had pledged more shares at the end of 2019 than at the end of 2018 despite the stock price was substantially higher. It is possible he borrowed money using extra share pledges. If this money was invested in out of the money weekly call options I suppose the resulting stock price increase has increased his borrowing facilities. It is even possible he borrowed more money at every stock price increase to invest it in weekly out of the money call options.

Given the legal risks it might not be very likely insiders are involved in such a scheme. However we cannot rule it out. I find other signs of unethical behavior really troublesome: for example not doing recalls for the sudden unintended acceleration problem, going after short sellers and not paying small bills such as rent. Also allegations of frequent short visits to Mexico of the Tesla board members Elon Musk, Kimbal Musk and Gracias are worrisome.

Bottom line

A balloon might look strong and stable but wait, ... what happens when someone sticks a small needle in it?

Big pump schemes are quite common in financial history. With any pump there is a bagholder. And a time this bagholder will sell. Such pump schemes do not end well for most bagholders, especially those who got in near the end. In this case it might be even enough if some retail investors sell. So my opinion of the stock is still: strong sell.

Analyst's Disclosure: I am/we are short TSLA.

Global Deep Value Stocks is a long only newsletter. I do not discuss stocks like Tesla in Global Deep Value Stocks.

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