One of the best “rules of thumb” I know of is encapsulated in:
Jay’s Trading Maxim #25: When something goes parabolic in price, it ultimately ends badly.
Yes, there are ancillary issues like, how far will it go before it ends badly and how long will it last before it ends badly, but the point remains, ultimately it will end badly.
Tesla anyone?
When you reach this point…
Figure 1 – The way of it at at this time…
…you can sense that things are, ahem, getting ahead of themselves.
To put it into terms that most people can understand:
Herd immunity = Good
Herd Mentality = Bad
The argument is NOT the merits of TSLA as a company. The future prospect for growth and earnings is NOT relevant at the moment. What is relevant is that a whole lot of people (with a whole lot of money to invest – consider this: a person with a nice $500,000 house could sell their house and buy all of 3 shares of TSLA!) are doing a “Wal Mart at 5AM on Black Friday” thing – completely swept up. See Figure 2.
Figure 2 – TSLA “to the moon” (Courtesy ProfitSource by HUBB)
TSLA was up 12% at one point yesterday and then closed lower. A lot of “technical analyst” types will shout “key reversal” and suggest “that was the top.” I for one haven’t the slightest idea. Remember that during the Feb/Mar panic TSLA lost -64%, then rallied over +400% in a matter of months.
Repeating now, no one knows are far TSLA can run nor how long the advance might last. The only question to ask and answer is: “Is this a game you want to play?”
An Options Play if you Own TSLA
The purpose of this article is not to convince anyone to not own TSLA. +400% in a matter of months is a pretty, er, decent rate of return. No, the purpose of this article is simply to remind you that every party eventually ends. And parties that get totally out of control always end badly.
If you do own TSLA stock I believe that now is a great time to consider selling covered calls on at least a portion of your position. As you can see in Figure 3, the implied volatility for options on TSLA is once again soaring. This simply tells us that option premiums are very high – and that selling options may be the best play at the moment.
Figure 3 – TSLA option premiums are high (Courtesy www.OptionsAnalysis.com)
So, consider an investor who owns 200 shares of TSLA and is getting nervous but is not quite ready to sell. Our example position involves:
*Holding 200 shares of TSLA (trading at $1,497)
*Selling 1 Aug07 2020 TSLA 1500 call @ $200
*Selling 1 Aug07 2020 TSLA 1800 call @ $115
The risk curves appear in Figure 4.
Figure 4 – Risk curves for holding 200 shares of TSLA and selling 1 Aug07 1500 call and 1 Aug07 1800 call (Courtesy www.OptionsAnalysis.com)
*For selling the two calls the investor takes in $31,500 in premium (which is nice work if you can get it)
*The investors breakeven point between now and August 7th is now $1,339 a share
*If TSLA closes on 8/7 above $1,800 a share then all 200 shares will be called away, 100 shares at $1,500 a share and 100 shares at $1,800 a share. In this case the investor will generate a profit of $62,088 (plus any previously accumulated profit in the shares)
*If TSLA is unchanged at $1,497 on 8/7 the investor would keep the $31,500 in premiums received
Why sell 2 different strikes? The 1500 call maximizes income generated if the stock stays unchanged or declines while the 1800 allows the position more upside potential in case the stock takes another run at $1,800 a share.
Summary
I understand that most people reading this do not have the good fortune of presently holding 200 shares of TSLA. In essence, this is the investment equivalent to the old Steve Martin line about how to get rich (“OK, first get a million dollars….”, which for the record, would get you 668 shares of TSLA).
But remember that when option premiums soar on ANY stock you do hold, the potential to sell covered calls and take in a lot of premium is something to think about.
See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine
See also Jay’s “A Strategy You Probably Haven’t Considered” Video
See also Video – The Long-Term…Now More Important Than Ever
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented represents the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
