Tesla (TSLA) stock has pulled back since hitting a high of 695 earlier in the month and bullish traders wanting to take on some upside exposure can do so via an option trade called a risk reversal.
Risk reversals are bullish trades that involve selling an out-of-the-money put and using the proceeds to purchase an out-of-the-money call. On TSLA stock, this type of trade would only be appropriate for very large traders as the maximum risk is around $62,000.
Let’s take a look at how a risk reversal trade might look on Tesla stock.
Going out to the September 2021 expiration gives the trade plenty of time to work out. The September 620 put can be sold for around $123.80 per contract. Those proceeds can then be used to purchase a September 700 call option which was trading around $119.70 per contract yesterday. As the sold put is slightly higher than the bought call, the trader receives a credit into their account of $4.10 per contract or $410 in total.
However, don’t go thinking that this is the most the trade can lose. The 620 put has the same risks as owning the stock below that strike price. So the position has a total loss potential of $62,000, which would only occur if TSLA stock went to zero.
Trade Initially Performs Similar To Stock Position
The trade will initially perform similar to a long stock position and will profit as the stock rises, and suffer losses if the stock falls.
The risk reversal has an initial delta of 91 which means the combined position is roughly equivalent to owning 91 shares of TSLA stock.
If TSLA stock is between 620 and 700 at that expiration in September, both options expire worthless and the trader makes $410 in profit.
At expiration, larger profits will occur above a price of 700. The higher the stock goes, the better for this trade, as there is no limit to the profit potential.
For a trade like this, I would risk no more than 2% of my account and have a stop loss if TSLA stock breaks through 600.
Based on modeling estimates, if TSLA stock were to hit 600 in the next few days, the trade would be down around $4,400. If the stock were to hit 700, then the trade would see a gain of roughly $4,700.
It’s important to 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
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