By Lawrence G. McMillan
Tesla has recently been one of the most active and volatile stocks. However, what appears to the naked eye is not always the same when placed under the microscope of analytical mathematics.
Let’s begin by looking at the stock’s /zigman2/quotes/203558040/composite TSLA +2.55% one-year chart:
We can see that the stock was in a steady uptrend from May through October of 2021. Then, it experienced a strong rise into November. Since then, it has been volatile – swinging back and forth in wide ranges and generally moving lower. Note that the stock bottomed in the 550-570 area back in May 2021.
This action has increased both the realized volatility of Tesla stock and the price of its options. In reality, though, Tesla options are not very expensive on a historical basis. However, there is a pattern to the pricing of the Tesla options that presents itself as a highly viable strategy.
A look into Tesla volatility
Let’s begin with some analysis of the volatility of Tesla and its options. Currently, the stock’s 20-day realized (historical) volatility (HV) is 82%. I would not be too concerned with what 82% means statistically, but rather use it for comparison with other volatility measures. The 50-day HV is 70%, and the 100-day HV is 71%. So those are in the same general neighborhood.
This chart shows the 20-day HV overlaid on top of the chart of the stock.
The 20-day HV (top graph) was declining when Tesla was rising, from May through October 2021. That is typical. Since then, however, with Tesla swinging in a wide range, the 20-day HV has increased, although it has roughly stayed in a range of 55% to 90% since last November.
These historical volatilities come into sharper focus when we look at the implied volatilities of Tesla options. On a volume-weighted calculation, the composite implied volatility (CIV) of TSLA options is 71.4%. Since the historical volatilities were 82%, 70%, and 71%, that shows the implied volatility of Tesla options is “about right.” They are not overly expensive but nor are they cheap when we consider how fast the underlying stock has been moving around.
There is one more piece of information that we need to have to build an option strategy: a comparison of today’s implied volatility (CIV) with past daily readings of CIV. That is shown in the next chart.
You can see that the current CIV (71.3%) is toward the upper end of the range of CIVs over the past year. Last September, Tesla options were trading with an implied volatility of 31% — that is the low point on the Implied Volatility chart. In fact, over the past 600 trading days, the current reading of 71.3% is in the 67 percentile. The percentile is merely an easy way to state how expensive the options are, on a scale of 0 to 100. So they are a little bit “overpriced” but not tremendously so.
Option strategies to consider
Call purchase: So what option strategies make sense? If you are bullish on the stock, you are not really overpaying for an outright call purchase; the outright purchase of the at-the-money, June (17) 770 call costs 70 points, or $7,000 for one contract. That is a large dollar amount for one call, but statistically is not a terribly high price, for its implied volatility is about 75% — generally in line with the volatilities that were discussed above.
One could counter that dollar expense a little by creating a call bull spread – perhaps selling the Jun (17) 870 call against the call you are buying. That would bring in roughly $3,000 but would cap off your profit potential at 870.
As one can see from the accompanying stock charts, the stock could be above 870 very quickly if things turn bullish.
Personally, with the CIV in the 67 percentile, if I were outright bullish on the stock, I would not bother with a call bull spread because it caps off your profit potential. Call bull spreads only make statistical sense if the CIV is much higher – perhaps near the 90 percentile or higher.
Put purchase: Essentially, the same argument applies if you are bearish on the stock: buy the at-the-money put and don’t spread. There is a small argument in favor of a bear spread (for example, buy the June 770 put and sell the Jun 670 put) over the call bull spread, which we’ll get to in a minute.
Put sale: If one wouldn’t mind owning the stock at 550, the June (17) 550 put could be sold for about 8 points. That is where the support was on the above stock charts, and is an implied volatility of 90% — meaning that you would be selling an expensive option (since 90% is higher than the other volatilities discussed above).
The problem with a put sale is that if the stock drops below 550, one might not be so willing to own the stock. But the put sale can always be closed out for a loss if Tesla is falling.
Neutral strategy: A neutral strategy is generally one in which the strategist doesn’t necessarily hold a strong opinion about the forthcoming movements in the underlying stock, but rather can build an option strategy that makes money in a large number of outcomes. Neutral strategies have risk, though, and they cannot just be established willy-nilly without understanding the specifics of the strategy.
One strategy that seems to be viable here involves what is called a “skew” in the implied volatility of the options – particularly the put options. It is often the case with index options, and with stock options where the underlying stock is in a downtrend, that out-of-the-money puts are far more expensive than at-the-money puts.