Tesla is showing some improvement this week, rising above its 21-day exponential moving average.
Tesla stock is also trying to regain the 200 price level.
Today, I want to look at a strategy with a small income potential on the upside and a healthy profit zone on the downside.
The strategy is called a broken wing butterfly. 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.
Setting Up Tesla Broken Wing Butterfly
This results in less risk on one side and more risk on the opposite side.
Let's take a look at how a broken wing butterfly trade might be set up on Tesla stock.
- Buy 1 April 19, 170 put @ 3.30
- Sell 2 April 19, 190 put @ 8.90
- Buy 1 April 19, 200 put @ 13.40
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 $110. That means there is no risk if the stock remains above 200.
The worst that can happen is all the puts expire worthless leaving the trader with a $110 gain. Based on the capital at risk of $890, that works out to be a 12.36% return.
On the downside, the maximum loss can be calculated by taking the difference in the widths (10) multiplied by 100, minus the credit received. That gives us 10 x 100 — 110 = $890.
Maximum Gain On Tesla Stock Trade $1,100
The maximum gain can be calculated as 10 x 100 + 110 = $1,110.
The ideal scenario for the trade is that Tesla stock stays flat initially and then slowly drifts lower to close around 190 at expiration. There is a large profit zone between 180 and 200.
As the trade starts with delta of 7, so has a slight bullish bias to start. But that will flip to negative delta closer to expiry if the stock is still above 200.
In terms of risk management, I would set a stop loss of 20% of the capital at risk, or if Tesla breaks below 185.
According to the IBD Stock Checkup, TSLA stock is ranked No. 8 in its industry group. It has a Composite Rating of 44, an EPS Rating of 68 and a Relative Strength Rating of 17.
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
