With Tesla() stock going on a monster rally since the election, I want to look at income-generating trades in Tesla stock that show a substantial profit zone on the downside.
The strategy du jour? A broken wing butterfly, and we'll use put options because the strikes will all stand below Tesla stock's latest price. This helps to reduce assignment risk.
With a regular butterfly option trade, we normally place the wings at an equal distance from the short strike. But with a broken wing butterfly we leave a larger gap on a particular side.
This results in less risk on one side and more risk on the opposite side.
According to IBD Stock Checkup, TSLA ranks No. 2 in its group and has a Composite Rating of 88, an EPS Rating of 77 and a Relative Strength Rating of 95.
Tesla Stock: The Broken Wing Butterfly
Let's take a look at how a broken wing butterfly trade might be set up on Tesla stock.
- Buy one Nov. 29 expiration 270-strike put @ 2.85 per share
- Sell two Nov. 29 290 puts @ 6.50
- Buy one Nov. 29 300 put @ 9.40
Notice that the upper-price strike put (300) lies 10 points away from the middle sold put's strike price of 290, while the lower-priced put of 270 is 20 points away.
This broken wing butterfly trade will result in a net credit of $75, based on recent trading. This means there is no risk if Tesla stock remains above 300.
The Latest News On Tesla And Other Magnificent Seven Stocks
Gains And Losses
One result of this trade: all the puts expire worthless. In this case, the outcome leaves the trader with a $75 gain. Based on the capital at risk of $925, that works out to be an 8.11% return by the end of November.
On the downside, the maximum loss can be calculated by taking the net difference in the widths of the put strikes (10) multiplied by 100, minus the credit received. That gives us 10 x 100 – 75 = $925 per set of contracts. Calculate the maximum gain as 10 x 100 + 75 = $1,075.
The trade starts with delta of 3, so it has a slight bullish bias to start. But that will flip to negative delta closer to expiry if Tesla stock is still above 300.
In terms of risk management, I would set a stop loss of 20% of the capital at risk, or if TSLA broke below 290.
Please remember that options are risky and investors can lose 100% of their investment.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ.
