Monday, June 30, 2014

$TSLA - SIDEWAYS CAR?


The tale of many momo stocks (like $NFLX) is literally a carbon copy of each other considering their most recent peak in March to their aggressive fall in May now leading to re-tests of those highs. History often teaches us that when a stock experiences a re-test of it’s previous high from an aggressive sell-off then the first reaction to that re-test is either a period of consolidation or perhaps a brief period of pullback. The reason is simple – people who bought at previous highs are happy to get their money back so they become sellers, whereas others who completely missed the rally are waiting to get in so they buy on pullbacks. This push and pull scenario is ideal for a sideways consolidation until there is a resolution to one side or another – and usually (not always) this requires some sort of a catalyst.

If you overlay all this information on $TSLA, you know exactly what I’m talking about. Take a look at $TSLA’s weekly chart below, the “pink” line shows you the mirror image of the fall and the re-test of $260 level.



Look at the October timeframe when a very similar thing happened (red line) – the stock plunged 40% from $194 level in 8 weeks, and then recovered all of it in another 11 weeks. That’s very symmetrical. However, when the stock re-tested $194 level in Feb, my thesis above didn’t quite play out as one would expect as there was minimal consolidation (around 3 weeks) and almost no pullback until the stock made a new high of $265 and the interestingly pulled back to re-test that level 2 months later.

Why did the stock not react to the overhead supply at $194 and not consolidate before going higher? Well, that’s exactly why technical analysis is a probability based model – it’s never 100%. One could argue that the overall market was very bullish during that timeframe, or perhaps the momo fever was full on when the previous buyers didn’t want to get out…..whatever the reason might be, I personally think it was a bit of an exception than the rule. I chose to point this out so that readers are fully aware of past situations and use everything to make the best decisions.

If and when the stock re-tests the 250 to 260 range (it’s almost there), my analysis says that the stock will respond by either (at least) some consolidation or a mild pull back just in time to get ready for the next big catalyst which is earnings on 4th August. Hence I want to sell an Iron Condor 3 weeks out (July Expiration) so that the consolidation results in premium erosion that would benefit the structure. Here’s the trade:

TSLA ($243 Currently) July Expiration Sell 200/235/235/270 Iron Condor for a credit of $16
  • Buy 1 $200 Put for $0.32
  • Sell 1 $235 Put for $5
  • Sell 1 $235 Call for $12.7
  • Buy 1 $270 Call for $1.35
To Protect my structure of any wild moves in either direction, I like to buy some hedge (protection) by buying a strangle.

TSLA ($243 Currently) July Expiration Buy 1 205/260 Strangle for a debit of $2.4
  • Buy 1 $205 Put for $0.3
  • Sell 1 $260 Call for $2.1
Total Structure Cost: $2.4 Credit (Strangle) minus $16 Debit (IC) = $13.6 Debit

NOTE: I have not put this trade on yet, but if the stock enters the $250 area (over next few days) I want to sell this Iron Condor for about $17.5

If by July Expiration the stock remains between $218 and $252 then the trade makes money. Max Profit Potential is 100% which happens if the stock expires at $235 (although I plan on not keeping it till expiration)

Profit Target: 20%
Loss Target: 25%

RISKS – The main risk for this structure is if the stock continues to grind higher post the $250 resistance area – which is possible but seems not that likely based on my work (above) which is why my Strangle protection should help. I will certain keep a lookout for any breakout signs in which case might consider closing the trade early. As always, the most important risk mitigation in any option strategy is “Position Sizing” – so I will commit a  small portion of my portfolio to this trade (just as any other trade).

I do think $TSLA is in a good spot to move sideways until the next (earnings) catalyst shows it’s hand…which should result in rapid premium erosion since this structure is only 3 weeks out. Follow me @KingsHedge to stay updated on the trade’s execution alert & it’s management. Cheers!

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