Tesla ( TSLA ) is set to report fourth-quarter earnings Wednesday after the close. Options data shows that Tesla stock has an expected move of 9.1% — up or down.
TSLA has been one of the worst performing stocks over the past twelve months. But it has since shown some signs of life, bouncing from around 102 to 143. Tesla The stock is also trading above its 21-day exponential moving average. And it has the 50 day moving average.
Let’s break down how we can structure an options trade that fits the view that 1) we believe TSLA stock will remain within the expected range; and 2) investor response to the earnings report is likely to be positive.
Taking into account the money and call for the January 27 expiration, we see that the expected range is 9.1%.
Tesla stock today
Now that we know the expected range, let’s find a bull put spread on Tesla stock with a short strike of about 9.1% below the stock price.
Selling the put option expiring on January 27th with a strike price of 128 and buying 123 puts would create a bullish spread.
That spread was trading for about $0.60 on Tuesday. This means that a trader who sold this spread would receive $60 in option premium with a maximum risk of $440.
This represents a risk return of 13.6% between now and Friday if TSLA remains above 128. If Tesla stock closes below 123 on the expiration date, the trade loses $440.
Breaking even at that price
The breakeven point for the bull put spread is 127.40, calculated as 128 minus the 0.60 option premium received per contract.
There’s little room for adjustment with short-term trades like this held above earnings — even with Tesla stock. Short-term trading also contains assignment risk.
A 14% return in a few days would be nice, but the possibility of losing 100% is also very real.
Therefore, this type of trading is only for traders with a high risk tolerance and should use the appropriate position size.
Bearish traders could trade the bear call spread version and neutral traders could use an iron condor similar to this example on Microsoft (MSFT).
Depending on how TSLA trades on Wednesday, traders may prefer to wait for a price higher than $0.60 for the spread or could adjust their strike prices.
According IBD Stock ControlTesla stock ranks third in its peer group and has a Composite Rating of 46, if EPS rating of 74 and a Relative stamina rating from 5.
Remember that options are risky and investors can lose 100% of their investment.
Gavin McMaster has a Masters in Applied Finance and Investments. He specializes in income trading using options, is very conservative in his style and believes that patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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