Options Corner: Tesla Could Charge Back Under The Volatility Sweet Spot

Ever since Tesla Inc. TSLA CEO Elon Musk waded aggressively into politics, the brand has encountered drama beyond the fierce rivalry found in the automotive sector.

This past week has been particularly brutal from a reputational standpoint. Tesla investors are anxious. However, the current volatility appears manageable, boding well for those seeking a discounted long position.

Over the past few weeks, sales data for electric vehicles across various regions have shown declines in Tesla's market share. Among the most conspicuous erosions was in Germany, where the EV manufacturer's sales plunged 59.5% in January. That same month, EV battery sales were up 53.5% year-over-year in Germany.

In other words, the drop-off appears to be a Tesla problem, not an issue impacting the broader EV market. Notably, a Brand Finance survey revealed that some respondents shied away from recommending or considering to buy a Tesla vehicle in part to Musk's controversial political stance.

Meanwhile, Tesla sold 63,238 China-made vehicles in January. Unfortunately, this tally marked a dip of 11.5% from the same period one year prior. Fundamentally, the EV leader faces significant pressure from domestic Chinese competitors, some of which are witnessing robust increases in market share.

If that wasn't distracting enough, Kimbal Musk — Elon’s brother and a director at Tesla — along with other insiders sold millions of dollars' worth of shares. To be fair, insiders sell equity ownership of their companies for a variety of reasons, many of them mundane. However, at a time when Tesla stock could use some positive headlines, an insider sell isn't exactly an encouraging development.

Investors Are Incentivized To Play The Numbers Game

After all these terrible headlines, the kicker could be that even before the onslaught, traders anticipated troubled waters. On Feb. 5, Tesla represented a highlight in Benzinga's screener for unusual options activity. This screener is a useful tool because it potentially represents sentiment among institutional investors — the folks that really move the market.

At the time, 65% of traders showed bearish tendencies. On paper, that does not sound appealing for prospective investors. However, the details matter. The bulk of the bearish bets were purchased put options that expire today. From next week onward, this bearish overhang will have been removed, possibly allowing Tesla stock more breathing room to the upside.

What's also enticing is that the numbers favor taking a long position in Tesla — so long as the volatility doesn't get out of hand. Investors should note that stochastically (viewing pricing data over the past five years from purely a temporal basis), TSLA features an upward bias. Specifically, a position entered at the beginning of the week has a 53.26% chance of rising by the end of it. Over a four-week basis, the long odds improve to 55.43%.

However, the math gets more compelling based on certain conditions. At this moment, TSLA stock is trending to lose no more than 5% of value for the business week ending Feb. 7. Whenever TSLA loses up to 5% during a one-week period, the long odds for the subsequent week stand at 55.07%. Over the next four weeks, the chances of upside improve to 60.71%.

The caveat is that the statistical framework begins to favor the bears under more robust volatility (around 7% weekly loss or worse). Therefore, it's imperative that TSLA's red ink stay in the sweet spot — volatile enough to make investors believe the equity is on discount but not too volatile to scare them away.

Plotting An Effective Options Strategy

Assuming that Tesla stock loses around 5% of value this week, the statistical framework leans to the bullish side of the spectrum over the next four weeks. Further, assuming the positive scenario wins out, the median return clocks in at 13.59%. Under the negative scenario, the median loss sits at 9.2%.

With this market intelligence, there's a solid possibility that by the close of the March 7 session, TSLA stock could either rise to $418 or decline to roughly $334. With that in mind, arguably the most balanced bullish strategy is the 330/415 bull call spread for the aforementioned expiration date. This transaction involves buying the $330 call and simultaneously selling the $415 call, with the aim that TSLA will rise or exceed the short strike price.

However, one drawback of this transaction is the cost. This trade requires a net debit (at time of writing) of $4,045 for the chance to earn a maximum payout of $4,455. It's expensive because the $330 long call is deep in the money (ITM).

Now, one reason why traders choose a deep ITM long call in their bull spread is that it provides protection. If the thesis goes awry, the ITM call provides salvageable value. However, aggressive speculators can elect spreads where both calls are out the money (OTM).

Such an approach is similar to a bootleg play in football — it puts the quarterback at risk but the gains could be phenomenal. One of the cheapest (but extremely aggressive) bull spreads is the 410/415 for the March 7 expiration date. This trade requires only $105 in net debit but the maximum payout (should TSLA reach or exceed $415 at expiration) stands at a whopping $395 or a payout of over 376%.

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