Name That Trade – $TSLA: Whistling Outside the Stash House

by Dan August 14, 2015 12:59 pm • Commentary

Last week on August 5th, despite reporting eps losses that were less than expected, and revenues that were inline, Tesla lowered full year 2015 car delivery estimates from original guidance of 55,000 to between 50,000 and 55,000.  This sent shares down 9% the following day, and now down about 15% from the 2015 high made in mid July.

Another concern from the Q2 conference call was the accelerating cash burn. The company is in the throes of not only producing two models, but also building its “gigafactory” and developing its stationary storage product.  Overnight the company addressed the liquidity concerns stemming from the cash burn by selling 2.7 million shares at $242 a piece and raising $652 million, with CEO Elon Musk buying $20 million worth of his own stock!

TSLA stock remains one of the most controversial stories in the entire U.S. stock market, given its rich valuation and accelerating earnings losses with the backdrop that (at the moment) they only make one luxury electric automobile that many estimate they lose $4,000 on… each one sold.  And while lower gas prices are not likely impacting current buyers’ desire to pony up $100,000 for a tricked out Model S or the upcoming suv Model X, lower for longer oil could change the way crave electric cars as we get closer to the expected 2017 launch of TSLA’s mass market Model 3.

Frankly, I am very conflicted on the TSLA story.  Musk is a clear visionary, a risk taker and likely one of the most interesting people on the planet (whether you feel he is from this planet is not particularly relevant to the argument). He has embarked on a path that few have ever succeeded on, disrupting the largest and most established automakers on the (this) planet.

In a year where the S&P 500 is essentially flat and trading in a very tight range for months, it is clear that investors are willing to pay for growth at any cost (see AMZN up 72%, FB up 22% and NFLX up 154% ytd.)  But here is the thing, those companies are delivering on their promise, all of which are far easier than that of making (TSLA has done this) but more importantly mass producing and profiting from (remains to be seen) the most sophisticated cars the world has ever seen. The production glitches in the Model X that caused delays are not likely to last, but as the company shifts to managing multiple growth initiatives, there will be many bumps in the road ahead.

We have kept a close eye on the chart of TSLA, waiting for what we think could be an inflection point, highlighted by an exhaustion of the 57% gains from the late March 52 week lows, to the recent highs.  On a few occasions in the last couple months we asked the question of whether or not the consolidation between $260 and $280 was the formation of a right shoulder of a head and shoulders top formation:

TSLA 1yr chart from Bloomberg
TSLA 1yr chart from Bloomberg

That also remains to be seen. There are no shortage of risks in the near term to the company’s execution, with the backdrop being that investors may have a fairly itchy trigger finger if those bumps in the road do manifest. It is my personal belief that in the coming months the increasing volatility in global risk assets will come home to roost in a significant sell off on our shores and controversial, much loved stocks like TSLA could retest recent lows.

But that is a guess, and selling a stock like this that you have a positive long term outlook in (like I do) just because the market broader market may correct would be silly.  Which is why I want to detail what we call a stock replacement strategy that offers a wide range to be able to absorb a decent correction in the market (and this stock) while keeping bullish exposure in one of the most exciting companies we’ve seen in some time:

Hypothetical Stock Replacement strategy in lieu of 100 shares of TSLA at $243:

Buy the Jan16 200 / 290 Risk Reversal for even money

-Sell to open 1 Jan16 200 put at $10

-Buy to open 1 Jan16 290 call for $10

Break-Even on Jan16 Expiration:

-Profits: above 290, (up 18%)

-Losses: below 200, (down 18%)

Mark to Market: this trade structure will have losses as the stock moves lower towards the short put strike, and gains as it moves closer to the long call strike. Today it is about 50 deltas. As time goes on with the stock in the middle of the range those deltas will decrease towards zero with no money lost. If the stock is below the 200 strike or above the 290 strike those deltas will increase towards 100 as time goes on.

Rationale:  If you believe that, despite lowered expectations, the company still faces near term execution challenges that could adversely affect investor sentiment in the near term, and you are willing to forgo near term profits on small moves higher in favor of a less immediate risk but still benefit if the stock makes new highs by Jan expiration, then this sort of strategy can serve as an attractive place holder as the company enters a critical execution phase. It is 50 deltas and if replacing long stock that means the risk reward of moves in the meantime is half of stock. Above the call strike or below the put strike and it is more like stock, especially as we get towards the end of the year.

I want to be clear, we are not near term bullish in TSLA here, but we think this trade structure offers an attractive risk reward for those looking to mitigate some near term risk in the stock down to $200 while keeping an overall bullish thesis through year end. If this is a new trade entirely we prefer this to buying stock here in the middle of the recent range.