Tesla is showing up my on screen for having a low implied volatility percentage. That means options are cheap relative to the last 12 months. So today let's look at a reverse butterfly trade in TSLA stock.
A reverse butterfly looks a bit like a long straddle, but we can reduce the cost by selling the outer wings. This keeps the cost of this trade in TSLA stock lower. But it also puts a limit on the potential gains.
Long straddles on TSLA stock are very expensive, because the option prices are so high.
Four Years After Cybertruck Debut, Tesla Begins Deliveries
TSLA Stock Today: The Trade
Another idea: trade a reverse butterfly, which would be constructed as follows:
- Sell 1 in-the-money call
- Buy 2 at-the-money calls
- Sell 1 out-of-the-money call
The trade will benefit from a big move in either direction from Tesla stock within the next few weeks.
Let's take a look at how that might look on TSLA stock as of Tuesday trading:
- Sell 1 Dec. 29-expiring call with a 210 strike price at 31.35
- Buy 2 Dec. 29 240 calls at 10.10
- Sell 1 Dec. 29 270 call at 2.00
In total, the trade would generate around $1,315 in premium (that's also the maximum possible gain) per set of options. Maximum risk gets capped at $1,685. (Note that with TSLA stock rising on Wednesday, the option premiums have since changed.)
What the trade is looking for is a quick price move in either direction. The trade loses value each day through time decay while TSLA stock remains between the break-even points of 223.15 and 256.85.
To calculate these break-even levels, take the lower strike price (210) and add the premium received (13.15). On the upside, take the upper strike (270) and subtract the same premium.
The Stop Loss Level
For a trade like this I would set a stop loss of 20%, which is around $260.
A reverse butterfly is a nonstandard option trade and therefore not recommended for beginners.
According to IBD Stock Checkup, TSLA stock ranks fifth in its group and recently showed a Composite Rating of 84, an EPS Rating of 88 and a Relative Strength Rating of 83.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
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 Twitter at @OptiontradinIQ
