Tesla stock looks to be holding above support at 215 for now, and today I want to look at a strategy with a healthy income potential on the upside and a substantial profit zone on the downside.
The strategy is called a broken wing butterfly and we'll use puts because the strikes will all be below the stock price. This helps to reduce assignment risk.
With a regular butterfly option trade, the wings are placed 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.
Building Tesla Stock Trade
Let's take a look at how a broken wing butterfly trade might be set up on Tesla stock.
- Buy 1 Sept. 20, 190 put @ 2.65
- Sell 2 Sept. 20, 210 put @ 6.60
- Buy 1 Sept. 20, 220 put @ 9.95
Notice that the upper strike put is 10 points away from the middle put, and the lower put is 20 points away.
This broken wing butterfly trade will result in a net credit of $60, which means there is no risk if the stock remains above 220.
If all the puts expire worthless, it leaves the trader with a $60 gain. Based on the capital at risk of $940, that works out to be a 6.38% return.
On the downside, the maximum loss is calculated by taking the difference in the widths (10) multiplied by 100, minus the credit received. That gives us 10 x 100 – 60 = $940.
The maximum gain is calculated as 10 x 100 + 60 = $1,060.
Ideal Scenario For Tesla Stock Trade
The ideal scenario for the trade is that Tesla stock stays flat initially and then slowly drifts lower to close around 210 at expiration. There is a large profit zone between 200 and 220.
The trade starts with delta of 4, so has a slight bullish bias to start. But that will flip to negative delta closer to expiry if the stock is still above 220.
In terms of risk management, I would set a stop loss of 20% of the capital at risk, or if Tesla breaks below 200.
According to the IBD Stock Checkup, Tesla stock is ranked No. 3 in its industry group. It has a Composite Rating of 68, an EPS Rating of 59 and a Relative Strength Rating of 75.
It's important to 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
