Right now, the investing world is focusing on shares of Tesla (TSLA 4.53%), which has been on a tear the likes of which few have ever seen before. In just the first two trading days of February, the electric vehicle specialist's share price has gone from $650 to nearly $900, having briefly approached $970 per share during Tuesday's session. In the process, Tesla has achieved megacap status despite still having posted a loss over the past 12 months.
There's a lot of disagreement about where Tesla stock is likely to go next. But among the arguments between those who the share price will continue to soar and those who expect it to plunge back to earth, there's one thing that people seem to agree on: up or down, Tesla's going to have a volatile stock for the foreseeable future.
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What options markets are saying about Tesla
Many stock investors don't pay much attention to options, especially investors with a long-term mindset. In many ways, the options markets are tailored more to traders than to long-term investors, as many options get their value from the potential for a stock to make big moves in short periods of time. And what options are saying about Tesla is that the roller-coaster ride is likely to continue for some time.
Specifically, here's where the options markets ended Tuesday with Tesla:
- The price of a call option to buy Tesla stock for $900 per share sometime between now and Feb. 21 -- just two and a half weeks from now -- sold for about $95 per share.
- The price of a corresponding put option to sell stock for $900 per share by Feb. 21 sold for roughly $100 per share.
Consider the implications of those prices. Those who buy call options will need to see Tesla stock reach almost the $1,000 per share level within the next 13 trading days just to break even on their option purchase. Even if it ends up at $990 -- up another 10% in just two and a half weeks! -- Tesla call option buyers will end up losing money.
At the same time, those betting against Tesla stock need an even bigger move. It'll take a drop to $800 to break even -- meaning that a 10% decline to $810 won't be enough to avoid a loss on that options position at current prices.
The riskiest Tesla bet around?
Just about the only thing no one seems to expect is for Tesla stock to stay steady at current levels. Yet the options markets are paying you a lot of money to make that bet -- known to options traders as selling a straddle.
For instance, if you were to sell a Tesla $900 call and a Tesla $900 put, then you'd be guaranteed of making money on at least one of those positions. At current prices, you'd receive $195 per share for selling those two options. The resulting outcomes depend on what the stock does between now and mid-month:
- If the stock price stays at $900, then you've hit the jackpot. Neither option would be exercised against you, and you'd pocket the $195 per share.
- If the stock price falls to somewhere between $705 and $900, then the put option would get assigned to you, and you'd have to pay $900 per share for stock worth less than that. However, the total of $195 per share you got for selling the options would be enough to offset those losses.
- Similarly, if the stock price rises to between $900 and $1,095, then the call option would get assigned to you. You'd have to purchase stock at a higher price and then deliver it to the option buyer in exchange for $900 per share in cash. However, that $195 per share from the option sale would again cover your losses.
- If the stock either falls below $705 or rises above $1,095 per share, you would end up with a net loss.
What this means for long-term investors
You don't have to buy or sell options in order for what's happening in the options market to be relevant. If you're a long-term investor looking to decide whether to buy shares at these levels, what the options market is telling you is that there's likely to be a lot of sharp share price movements due to all the speculation in the stock right now. You therefore have to have rock-solid emotional discipline -- and if you decide to buy Tesla shares, you have to be prepared for them possibly to lose a lot of value right away.
In the long run, fundamental business strength defines the course of prices of top stocks. But what's happening with Tesla over the past two days isn't about changes to the carmaker's future prospects but rather about excited investors placing short-term bets. Knowing what you might be getting into is important if you're planning to invest in Tesla right now.
