Tesla's phenomenal run looks like it might be coming to an end with the stock down over 8% Wednesday.
With the stock under pressure, I'm willing to bet that it will trade sideways at best over the next few weeks.
Today, I'm looking at a bear call spread that assumes Tesla will struggle to get above the 520 level, which would be 6.4% above the all-time high.
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy can be profitable if the stock trades lower, sideways, and even if it trades slightly higher, as long as it stays below the short call at expiry.
Tesla Volatility Offers Advantage
With volatility through the roof, we can also place our strike further away from the stock price than usual.
A Jan. 17 expiry bear call spread on Tesla using the 520-525 strike prices could be sold for around $0.75 late Wednesday.
Using the 520 strike as the short call gives plenty of margin for error if Tesla does bounce from here.
Traders selling the spread would receive $75 in option premium, which is also the maximum possible gain. The maximum loss would be $425.
Potential Return Of More Than 17%
That represents a potential return of 17.65% between now and Jan. 17.
The spread will achieve the maximum profit if Tesla stock closes below 520 on Jan. 17. In that case the entire spread would expire worthless, allowing the trader to keep the $75 option premium.
The maximum loss will occur if Tesla closes above 525 on Jan. 17, which would see the premium seller lose $425 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy, and you always know the worst-case scenario in advance.
Managing Tesla Trade
A stop loss could be set if Tesla trades above 500, or if the spread value rises from $0.75 to $1.50.
Because this is a bearish position, traders who think Tesla could move higher from here should not enter this trade. The position starts with a delta of -1, meaning it is roughly equivalent to being short 1 share of Tesla.
A bear call spread can also act as a small hedge for long stock holders.
According to the IBD Stock Checkup, Tesla is ranked No. 1 in its industry group. It has a Composite Rating of 94, an EPS Rating of 78 and a Relative Strength Rating of 98.
Tesla has already reported Q3 earnings, so this trade should have no earnings risk.
The last bear call spread we looked at, Dec. 10 on Qualcomm, is working well so far.
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 X/Twitter at @OptiontradinIQ
