MorningWord 11/24/14: $TSLA – Stock Alt and Battery

by Dan November 24, 2014 10:12 am • Commentary

Bond investor Jeff Gundlach (founder of Doubline Capital) has had a few choice words on some fairly high profile stocks over the last few years.  He has been back and forth on Apple (AAPL), calling the story ‘Overbelieved and Overbought’ back in September 2012 prior to the stock’s 45% peak to trough decline and then changing his tune in late 2013 prior to the stock’s rally back to the previous highs. Obviously, just because the guy is considered to be one of the best bond investors in the world does not make his word gospel on single stocks. But the stock’s that he has chosen to opine on like AAPL, Chipolte (CMG) and Tesla (TSLA) have captivated the investing public.

Earlier this summer Gundlach had some thoughts on Tesla’s potential to redefine the energy business, and not as a carmaker. In a Bloomberg interview with Barry Ritholtz (listen here, TSLA 20 mins in) Gundlach suggests that Elon Musk go to the major auto companies and make them a long term deal on his batteries and forget the car business.  While he thinks it is a low probability Gundlach seems to think that the stock would not be overvalued at current levels as a battery company. So he’s “sort of bullish on Tesla as a speculative investment”.

Here were some excerpts, per BusinesInsider on July 13th, 2014:

“I just think that the battery technology that Tesla has developed is so far ahead of everybody else that it could really have broad uses,

“If I was running GM, or BMW or Ford, I would be open to the idea of just buying the batteries from Tesla.”

“If Tesla is able to increase this lithium battery power to a certain point, it could power your house — you could get away from public utilities, you could think of of ubiquitous usage of this battery technology that could have incredible monopolistic profit potential.”

Well, maybe Musk doesn’t even have to get out of the car business. Maybe they are so far ahead on their battery technology that Tesla can be the sort of Samsung of the consumer electronics business in the autospace, selling components to almost every oem while also competing with them on the final product. This view will surely have bumps in the road but it could sustain the stock through any short term stumbles.

So overnight, Musk was quoted in a German newspaper (here) that TSLA is speaking to BMW:

“about whether we can collaborate in battery technology or charging stations”

Despite the BMW news, the thesis could take years to play out, with a good bit of volatility in the meantime.  So in a speculative stock like TSLA I would look to structure any long term trades to have the greatest likelihood of an outcome that would be PnL neutral, but offering the potential for an asymmetric return to the upside.

For example, with the stock about $241, I would look out to Jan 2017 expiration (more than two years from now) at risk reversals (sell an out of the money put to buy an out of the money call.)  The Jan17 150/380 risk reversal would cost about $4 (selling the  Jan17 150 put at $18, and buying the Jan17 $380 call for $22).  This structure has only about 18 deltas (the calls have about 33 and the puts about 15.)  The options market is saying there’s a 33% chance the calls are in the money on Jan17 expiration, and only 15% chance that the puts are.  If the stock were to close between $150 and $380, the trade would suffer a $4 loss. Below $150 (down $90 or about 37%) the trade losses dollar for dollar. Above $384 (call strike less the premium paid) gains are unlimited.  This trade is asymmetric because it risks $4 in it’s most likely scenario, has risk like stock much lower than where it is trading but has no limit on potential profits to the upside.  If Gundlach is correct, and TSLA has the potential of turning multiple long standing industries upside down, this is the sort of time horizon and risk profile that could make sense as opposed to simply owning the stock and all the near term volatility that comes with that position.