Tesla Stock Is Down but Still Treading Water - Ideal for Put Option Short Sellers as an Income Play

Tesla Inc (TSLA) stock is off 24% since early July and fell further after the July 23 release of its Q2 results. It has been treading water lately below $200 with high put option premiums. That is ideal for short sellers as an income play - selling short out-of-the-money (OTM) puts in nearby expiry periods.

In mid-day trading on Monday, Aug. 12, TSLA is at $197.38, down 23.4% from $257.86 on July 10. However, since the end of June 30 (i.e., the whole of Q3) it has stayed flat at just under $200 per share.

Nevertheless, the stock's put option premiums are very high. Short sellers can take advantage of this by shorting them in near-term expiry periods. 

That provides extra income, especially for existing shareholders who also could gain from any increase in the stock price. One reason is that Tesla stock looks cheap here.

Tesla Stock Could Be Undervalued

I discussed this in a recent article on Tesla. My July 24 Barchart article showed that despite the company's poor quarterly results, TSLA stock could be cheap.

For example, the market has been upset that despite a 2% YoY rise in overall revenue, its automotive sales were down 7% Y/Y. However, its operating income was still positive and it generated $1.34 billion in free cash flow even after $2.27 billion in capex spending.

That represented a 5.26% FCF margin (i.e., $1.34b/$25.5 billion in sales). That augurs well for the company going forward.

For example, analysts forecast sales will rise to $116.23 billion next year, up over 16.8% from $99.49 billion forecast for 2024. Therefore, if Tesla can keep making high FCF margins, its value is likely to rise.

Target Price Estimate

Let's assume that with higher sales its FCF margin rises to 7.5%. Its free cash flow will hit $8.72 billion (i.e., 0.75 x $116.23 billion in forecast 2025 sales).

As a result, using a 1.0% FCF yield metric, its market cap could rise to $872 billion (i.e., $8.72/0.01). That is 37.9% over its present $632.3 billion market value. In other words, TSLA stock could be worth $272.19 per share (i.e., $197.38 x 1.379).

But just be conservative, let's say its FCF margin rises to just 6% and sales rise just 15% to $114.4 billion next year. That implies that its FCF will be $6.865 billion (i.e., 0.06 x $114.4b = $6.865b).

Therefore, its market cap, using a 1.0% FCF yield metric, will be $686.5 billion. That is still 8.56% over today's $632.3 billion market value. That results in a price target of $214.28 per share.

In other words, our price target range is between $214 and $272 per share, or $243 per share on average. That is is still 23% over today's price.

One way to play this is to sell short out-of-the-money (OTM) put options, given their high premiums.

Shorting OTM Puts

For example, look at the Sept. 6 put option expiration period, which is just over 3 weeks away (25 days). It shows that the deep out-of-the-money (OTM) puts still have high premiums. That makes them ideal as income plays.

The $175 strike price put option now trades for $2.80 on the bid side. This strike price is well over 10% below today's stock price. The short seller can make an immediate yield of 1.60% (i.e., $2.82/$175.00).

TSLA puts expiring Sept. 6 - Barchart - As of Aug. 12

That means that an investor who secures $17,500 with their brokerage firm can enter an order to “Sell to Open” 1 contract at $175 and immediately receive $280 in their account. That works would to an investment return of 1.60%.

As long as the stock stays over $175.00 the investor will not be obligated to 100 shares per contract shorted at the $175.00 strike price.

Moreover, if the investor can repeat this every 3.5 weeks for a quarter they stand to make an expected return (ER) of $840 in their account (i.e., $280 x 3). That represents an ER yield of 4.8%. This is a very good return for most investors.

In addition, if TSLA stock rises, existing investors can capture that return as well. That is why it makes sense for existing investors, who already believe in TSLA stock, to sell short OTM puts in TSLA stock.

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.