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Tesla (TSLA) stock has had a huge volume of deep-in-the-money (ITM) call options traded today. This is ahead of its Q3 earnings due out after the market closes. The ITM trade suggests bullish investors.
In early trading on Wed., Oct. 18, TSLA stock was trading at $248.12. However, the Barchart Unusual Stock Options Activity Report today indicates that over 15,000 call options have traded in the $190.00 strike price calls expiring on Nov. 17. This is over 28 times the existing number of contracts already outstanding as seen in the Vol/OI column in the table below.
That means that they are deep-in-the-money (ITM) by at least $58.12 per share (i.e., $248.12-$190.00).
The midpoint price of the calls was $59.95 per share, so they are trading at a premium of $1.83 (i.e., $59.95-$58.12), or 3.5% (i.e., $1.83/$58.12). In other words, some large investors were willing to pay a 3.5% override or premium over today's price for these call options that expire in 30 days.
One reason they might be willing to do this is they believe TSLA stock will rise much more than 3.85% over today's price in the next 30 days. That way the call options would end up profitable for them to exercise to purchase more shares at a cheaper price.
But another reason is that they might find it easier and cheaper to simply buy call options instead of the underlying stock. For example, if you have $1 million to allocate in TSLA stock you can get exposure to 16,680 shares via calls expiring on Nov. 17, vs. just 4,030 shares buying TSLA stock.
Moreover, you don't necessarily have to wait for the calls to expire well in the money. That is because if TSLA stock rises, the call options will tend to rise as well, especially given that these calls are deep in the money.
For example, if the stock rises to $270 before Nov. 17, the calls will trade for more than the intrinsic value of $80 (i.e., $270-$190) up until then. However, the downside risk could be amplified. For example, if TSLA falls to $230, the calls will have an intrinsic worth of just $40.00 per contract, a drop of 33%. That compares to a fall of just 3.2% if the stock falls $8.12 from $248.12 to $240.00.
Where This Leaves Investors in TSLA Stock
These calls are not without a lot of risk. For example, analysts expect TSLA will report lower adjusted non-GAAP earnings per share (EPS) of 73 cents, compared to $1.05 last year Q3 2022. Moreover, this is despite a higher revenue line. For example, estimates are for $24.14 billion in Q3 2023 total revenue, vs. $21.454 billion last year, an estimated YoY 12.5% gain in sales.
Part of the reason is Q3 2023 downtime from two plants during the quarter as well as higher expenses relating to the upcoming rollout of the Cybertruck.
In addition, free cash flow (FCF) could also be lower. Last quarter it was $1.0 billion, higher than the $600 million in Q2 2022. But this quarter it could be lower, as the Q3 2022 FCF level was $3.297 billion.
These down numbers could have a deleterious effect on TSLA stock, at least at first. Keep in mind that TSLA stock trades at a sky-high multiple of 76x 2023 EPS estimates and 55x 2024 forecasts.
So, if analysts lower their EPS projections after these lower Q3 profit numbers come out, the P/E multiple could contract, pushing TSLA stock even more.
The bottom line is that these in-the-money calls may be a safe way to play the stock if TSLA rises, but once the stock falls, the investor's downside could be amplified.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
