The stock market remains under pressure and the leaders of last year continue to falter. Tesla stock is nearly 40% off its high and recently crossed below its 200-day moving average line. This is typically a bearish sign.
A bear call spread option trade can profit should Tesla (TSLA) continue to struggle.
XBear Call Spread For Tesla Stock
Tesla stock has a Composite Rating of 76, an Earnings Per Share Rating of 74 and an RS Rating of 88. It's not nearly as strong as it was last year. With a relative strength line trending lower, it's lost its leadership position.
Shorting a stock when you're bearish is fine but can have issues. Among them: hard to borrow stocks, restrictions in non-margin accounts, and limiting your risk if you're wrong. A bear call spread solves many of those issues and can secure a profit with defined risk.
This option trade on Tesla stock is set up by selling an out-of-the-money call and buying a further out-of-the-money call.
On Tesla stock, a bear call spread expiring in June could be set up using the 625 strike as the short call and the 630 strike as the long call.
That spread was trading for roughly $1.80 at the close yesterday, which translates to $180 of income for the option trader per contract.
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The strategy can be profitable if Tesla stock trades lower, sideways and even if it trades slightly higher by expiration. The critical point is that it stays below the short call at expiration.
Profit And Loss For The Trade
The maximum profit on the trade would be $180 per contract. That's the premium you took in and it's yours to keep should the entire spread expire worthless with Tesla stock below the 625 strike.
The maximum loss is $320 per contract. You calculate it by taking the difference between the strikes of the long call and short call (in this case 5) and subtracting the premium received. This would happen if Tesla stock ends above the 630 strike at expiration, but you could always cut the loss sooner.
Unlike shorting a stock, this is a risk-defined strategy. You always know the worst-case scenario in advance.
With the maximum profit at expiration, this bear call spread on Tesla stock has a potential return of 56.25% relative to the risk in about a month's time.
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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