Tesla is showing some interesting volatility skew at the moment, with low volatility in the short-term options but high volatility in the long-term options.
When it comes to options, we normally look at short-term trades — anywhere from one week to one month.
Today, we will look at a longer-term iron condor on Tesla stock.
With volatility staying low for now, there is more value in selling the longer-term, higher volatility options.
The implied volatility level for the May 19 options is around 46%, while the Aug. 18 expiry is showing implied volatility of around 59%.
Longer-term trades also tend to move a little slower than shorter-term trades. That allows more time to adjust or close, but does mean a lower annualized return.
Another advantage is that if there is a volatility spike, longer-term options tend to be less affected than short-term options.
Tesla Stock Long-Term Iron Condor
As a reminder, an iron condor can be set up via a combination of a bull put spread and a bear call spread.
The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction.
First, we take the bull put spread. Using the Aug. 18 expiry, we could sell the 130 put and buy the 125 put. That spread could be sold Wednesday for around $0.85.
Then the bear call spread can be placed by selling the 230 call and buying the 235 call. This spread could be sold yesterday for around $0.40.
In total the iron condor will generate around $1.25 in premium.
The profit zone ranges between 128.75 and 231.25. This can calculated by taking the short strikes and adding or subtracting the premium received.
Because both spreads are $5 wide, the maximum risk in the trade is 5-1.25 x 100 = $375.
Potential Return Of 33%
Therefore, if we take the premium ($125) divided by the maximum risk ($375), this iron condor trade has the potential to return 33.33%.
If price action stabilizes, then iron condors will work well. However, if Tesla stock continues to bounce around, the trade will suffer losses.
One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $125, so could set a stop loss at 1.5 times the premium, or around $190.
Sticking to this stop loss level will help avoid large losses if the trade goes south.
According to the IBD Stock Checkup, Tesla stock is ranked No. 7 in its group and has a Composite Rating of 59, an EPS Rating of 93 and a Relative Strength Rating of 20.
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Please 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 Twitter at @OptiontradinIQ
