If you have ever driven, or been driven in a Tesla car, you know that it is an exceptional piece of machinery. Of course the price of that machinery and the environmental benefits are hotly debated among auto aficionados relative to other luxury sedans and SUVs that run on gasoline. Whether it is amongst consumers, competitors or investors, talk of Tesla it is usually filled with some controversy. I’m not really a car guy, but from an investor/trader’s point of view, there are few stocks in the market that elicit such a visceral response from both bulls and bears.
The bull story is fairly well known at this point, and frankly, its one that we have become fairly familiar with over the last few decades specifically as it relates to tech stocks (Jobs, Bezos, Zuckerberg, Hastings etc). A visionary founder peddling a product that consumers don’t yet know they need yet. But unlike those other CEOs, Elon’s Musk’s involvement in other passion projects such as SpaceX and SolarCity (which TSLA acquired in 2016) and Boring Company/Hyperloop, probably makes him the most controversial of the group with investors. That is reflected in TSLA’s 24% short interest, nearly 8 years after its IPO. But the bulls remain in control long term, with the stock down only 14% from its all-time highs made just a few months ago.
I don’t have a strong view whether the stock is a long or a short at current levels. The fact that the company’s losses significantly accelerated in 2017 to (probably) $11 a share despite 67% yoy revenue growth, while their debt grew from $6.8 billion in 2016 to $9.8 billion in 2017 tells me that long holders of the stock don’t care about near-term losses, delivery target misses, debt loads and Musk being stretched thin. On the other hand, that persistent short interest tells me bears are willing to endure untold amounts of pain waiting for it all to come crashing back to earth.
It’s made little sense to compare TSLA as an investment to traditional auto companies on a valuation basis. But I would warn that it also makes no sense to compare TSLA to tech companies because at the end of the day, their existing product is still cars, and mostly expensive ones at that. Valuation doesn’t matter only for so long, especially if they are unable to stem losses and pay their debts. But in the meantime bulls will be fine with seeing a healthy ramp in Model 3 deliveries which would put them squarely in competition for mass-market electric vehicles with big boys like GM and Ford.
All that said, I have had two smart seasoned investors ask me in the last week how to construct a trade structure that gives them long-term bearish exposure in TSLA. The farthest expiration in the listed market is Jan 2020 (any bank would make over-the-counter markets in expirations and strikes that don’t exist for large institutional clients) but we’ll stick to exchange traded. It’s important to note that even on exhange traded options in popular stocks like TSLA that in very long-dated options, the liquidity can be poor, and the spreads very wide. You have to be convicted in these options because it will be expensive to get in and get out if far from expiration.
First let’s take a look at how TSLA acted last year. The stock rose 50% in the first 3 months of 2017, essentially going from $200 to $300. Then the next three months from $300 to nearly $400. The second half of 2017 was just as volatile with the stock closing very near the low end of the 6-month range and very near the mid-point of the one year range. The stock has held support on numerous occasions near $300 since April:
Backing the chart out to its 2010 IPO, that support level just below $300 is significant as it marked the long-term breakout after a multi-year consolidation:
Bulls might argue that the repeated hold at support might suggest a new consolidation range being created between $300 and $400. But my crystal ball is in the shop, so I’ll take this opportunity to answer my friend’s question of playing for ZERO in the stock over the next couple of years. Obviously not really a zero because few stocks go to zero, even if they filed for bankruptcy of some type the equity would not likely be total, but let’s look at a big move lower.
One way to do this, without having any tail risk (so to speak) other than the cost of the trade would be to purchase long-dated ratio put spreads. For instance, if you thought the stock could go be significantly below $250 in the next couple of years you might consider the following trade. (We’ll explain how this trade works in the rationale):
TSLA ($336) Buy Jan 2020 250 / 125 1×2 put spread for $20
- Buy to open 1 Jan20 250 put for $36
- Sell to open 2 Jan20 125 puts each at $8 for a total of $16
Break-even on Jan2020 expiration:
Profits of up to $105 between $130 and $20, max gain of $105 at $125
Losses of up to $20 between $250 and $230 & between $20 and zero with max loss of $20 above $230 or at zero.
Rationale: This trade risks $20 and can make up to $105 if the stock is between $20 and $220 on Jan 2020 expiration. The best way to think of this trade is like a 250/125/0 put butterfly, but where you don’t have to buy the last leg because the stock can’t go below zero. If the stock did go below $230 you would have profits with your only risk being if the stock is trading below $20. The maximum gain occurs at $125. That’s a wide range. This can be done with any strikes where the width of the 1×2 is equal to the width of the x2 strike down to zero. And sometimes they can be had for even closer to nothing. For instance the 200/100 put 1×2 in 2020 is about $8, of course it has a lower breakeven and would make less, but it risks alot less as well.
This is the sort of “set it and forget it” trade for those skeptical about a stock’s future, but when you have no idea when the wave would crest and don;t want to play the game of taking pain as the stock continues higher for the foreseeable future.