Tesla (TSLA) is to report fourth-quarter results after the market close on Wednesday. Options data shows Tesla stock has an expected move of about 9.1% — up or down.
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TSLA was one of the worst-performing stocks over the last 12 months. Since then, however, she has shown some signs of life, recovering from about 102 to 143. Tesla stock is also trading above the 21-day exponential moving average. And it has its sights set on the 50-day moving average.
Let’s analyze how to structure an options trade consistent with the view that 1) we believe TSLA stock will stay within expected range; and 2) investor reaction to the earnings report should be positive.
Looking at the at-the-money put and call for expiry on January 27th, we see that the expected range is 9.1%.
Tesla stock today
Now that we know the expected range, we’re looking for a bull put spread in Tesla stock with a short strike of about 9.1% below the stock price.
Selling the put option expiring on Jan. 27 with an exercise price of 128 and buying the put at 123 would create a bull put spread.
This spread traded at around $0.60 on Tuesday. This means that a trader selling this spread would receive an option premium of $60 with a maximum risk of $440.
That translates to a 13.6% risk return through Friday if TSLA stays above 128. If Tesla stock closes below 123 on the expiry date, the trade loses the full $440.
Break even at this price
The breakeven point for the bull put spread is 127.40, calculated as 128 minus the option premium received per contract of 0.60.
There’s little room for adjustment on short-term trades like this held above earnings — even in Tesla stock. Short-term transactions also involve attribution risk.
A 14% return in a few days would be nice, but the possibility of losing 100% is also very real.
Therefore, this trading style is only for traders with high risk tolerance and should use an appropriate position size.
Bearish traders could trade the bear call spread version and neutral traders could use an iron condor similar to this example Microsoft (MSFT).
Depending on how TSLA trades on Wednesday, traders may prefer to wait for the spread to price above $0.60, or they may adjust strike prices.
According to IBD Stock Checkup, Tesla stock ranks third in its group with a composite rating of 46, an EPS rating of 74, and a relative strength rating of 5.
Please remember that options are risky and investors can lose 100% of their investment.
Gavin McMaster holds a Masters in Applied Finance and Investment. Specializing in income options trading, he is very conservative in his style and believes that patience while waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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