Last week I got a call from a friend who told me that Tesla TSLA +4% stock could be my way to riches.
He noted that the stock was recently trading at $883 a share but that some people were buying call options at around $1,000 more a share. That’s approximately $1,900 if you were wondering.
“Tesla at $1,900 is free money,” he said.
How’s that? I asked.
Tesla Worth More than California’s Economy?
My friend, who doesn’t want to be named, noted that if Tesla stock made it to $1,900 then the company would be worth $1.8 trillion, according to my calculations based on data from Yahoo.
“That’s crazy,” he said. The point was that such a valuation was insane even though there are other tech companies that have market caps over a trillion dollars. (They include Amazon AMZN +0.1% and Apple AAPL +2.8%, for instance.)
He has a point. How could such a valuation could be justified?
It could not, my friend states.
One way to look at that is to compare it to the size of California’s economy, $3.1 trillion and home to some vast industries. To say that in one year’s time Tesla could be worth more than half of what would be the fifth largest economy in the world makes little sense.
Write Options at Around $1,900 And Pocket the Premium
That’s where the $1,900 and the free money comes into play.
He found that call options set to expire a little over a year from now and that had a strike price around $1,900 were selling for tidy sums. Call options pay out if the share price exceeds the strike price at the expiration date. Typically there are a hundred shares in a stock option contract.
For instance, March 18, 2022 calls at $1,810 recently fetched $519 a share.
That’s expensive to purchase given the tiny chance that Tesla stock rallies that much. But that bloated cost also means that anyone with the guts to sell an option at that price could make a lot of money.
It works like so:
From the moment you sell an option the remaining value of it starts to diminish. This is known as time decay — the more time that passes the more the value is depleted. This is especially true when the implied volatility of the stock option (i.e. the expected volatility which is used to price the option contract) is high. In simple terms the higher the implied volatility the higher the time decay.
“In general, the higher the implied volatility levels, the higher the Theta amount,” according to OptionsEducation.org.
In this case, Tesla options are a good thing to sell because in some cases the options contracts are based on exceptionally high implied volatility. The options listed above have an implied volatility of 332% recently, according to data from Yahoo.
The implied volatility of Tesla options currently averages 71%.
Or put simply, most options are priced for lower volatility than are the March 2022 calls at $1,810.
Will you see instance profits through time decay and therefore be able to buy back the options for a lower price? No, in the short term.
“This does not mean that investors can sell options in high implied volatility stocks and expect to earn time decay right away,” Options Education says.
But over a longer period probably yes.
The idea is that you’d sell one option contract for $51,900 ($519 * 100 shares) and then watch as the time decays that value. You’d either get to buy back the option cheaper or let it expire worthless.
Selling Tesla Options is High Risk
Still, if you do decide to sell call options with a long expiry date then you should understand that this is a high-risk trade. You could lose far more than the value of the price you get for selling the option because the price of the underlying Tesla stock could theoretically rise to infinity.
Source: Forbes
