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Tesla (TSLA) stock is now off over 11% in early trading on July 24 at $260.52 from its July 18 $293.34 peak. But this could be good news for traders who sell short out-of-the-money puts for both income and lower buy-in opportunities.
The company released its earnings on July 19, showing revenue approaching $25B in a single quarter. This was despite having significantly lowered its prices on certain popular models during the quarter.
Higher Free Cash Flow (FCF)
Nevertheless, this led to 10% higher deliveries during the quarter, and that helped grow its auto revenues by 6.53% QoQ to $21.68 billion.
Moreover, as we discussed in our July 3 piece, “Tesla's Surging Deliveries Imply Free Cash Flow Could Rise - Bullish For TSLA Stock,” its free cash flow (FCF) improved on a QoQ basis. For example, FCF rose from $0.44 billion in Q1 to $1.0 billion in Q2.
Again, this was despite lower prices in some models and capex spending that stayed level during both quarters.
So, despite the fact that the company indicated it might have to lower prices again, which is the cause for the stock weakness, there has been no major impact on its FCF. If that continues, it should give hope to investors and shareholders in TSLA stock.
It also makes shorting out-of-the-money (OTM) puts, whose premiums are very high, attractive for income investors.
Shorting OTM Puts in TSLA Stock
For example, traders who short sell the Aug. 18 expiration $242.50 strike price puts can make $6.10 per contract. This expiration is 25 days from now, a little over 3 weeks and the strike price is 5.75% below today's spot price of $260.52.
But the income opportunity is huge. For example, $6.10 represents a 2.52% yield for just 3+ weeks. That works out to an annualized return of 36.7% if it can be repeated every 25 days.
For example, here is what this means exactly. If a trader secures $24,250 with their brokerage firm (i.e., 100 shares x $242.50), they can then enter an order to “Sell to Open” 1 put contract at $242.50.
The account will then immediately receive $610. This shows that the yield is 2.52% since the $610 received works out to 2.52% of the secured investment of $24,250.
Moreover, the trader has protection down to $236.40 (i.e., $242.50-$6.10) before they begin to have an unrealized loss. That breakeven level is 10% below today's price.
In other words, TSLA stock would have to tank between now and Aug. 18 before the trader would be forced to not only buy the stock at $242.50, but also incur an unrealized loss in their holding.
Moreover, even if that occurs, the trader could turn around and sell short out-of-the-money call options to gain more income. In addition, the lower $242.50 buy-in cost from today allows the investor to get a bargain price.
However, this is not the same as holding the stock, especially if it rises above today's price. That is why often investors will both buy TSLA shares and short OTM puts in order to reduce their buy-in cost by the amount of the premium received.
The bottom line is that TSLA stock looks overly depressed here, especially if its FCF continues to improve.
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.
