One of my favorite topics in the stock market these days is Tesla Motors Inc (NASDAQ:TSLA). For anyone who likes an underdog story filled with drama and suspense, TSLA stock is as good as it gets.
Tesla — the company — has been an incredible success up to this point. TSLA stock has also been one of the best stocks in the market in the past five years. Unfortunately, the company now has extremely high expectations, and Tesla stock has an even higher valuation. I’ve been very critical of the bull case for TSLA. I wholeheartedly believe it’s one of the most dangerous popular stocks in the market today.
Yet I am the first to admit that if the Tesla story has a happy ending, it could easily double within the next couple of years. If not, I believe the bottom will fall out of the stock and the company may end up dead in the water.
The TSLA Stock Bear Case
In the past four quarters, Tesla shipped 76,000 automobiles, generated over $6 billion in revenue and registered $874 million in net income losses. Last year, General Motors Company (NYSE:GM) shipped 9.8 million automobiles globally.
In the past four quarters, GM generated $162.1 billion in revenue and reported net profits of $14 billion. Yet somehow, TSLA stock is valued at a market cap of $39.2 billion compared to GM’s valuation of $56.9 billion.
Why? The Tesla bull case involves the Model 3 and subsequent affordable Tesla models taking over the global mass auto market. If that’s the case, TSLA stock will eventually justify its absurd valuation.
I’m skeptical. Elon Musk has made too many promises that will require perfect execution to keep. Anyone who has operated in the business world knows things rarely go exactly according to plan. Tesla plans to ramp production from 50,000 in 2015 to 76,000 in 2016 to 500,000 in 2018. Musk also promises that Model 3s will begin shipping by the end of 2017 and will start at $35,000.
Just ask any TSLA stock bull, and those are the reasons they like the stock. To me, that means that at the bare minimum, all of those assumptions need to actually happen to justify Tesla’s current valuation.
TSLA Stock Is Too Dangerous to Short
Unfortunately for traders betting against TSLA stock, they have plenty of company. According to shortsqueeze.com, it has a short percent of float of nearly 30% with 8.7 days to cover. That means any dip in share price will likely be met with short covering. Any potential good news could also be followed by a huge short squeeze.
Despite my belief that TSLA stock is extremely overvalued, these risks have kept me away from ever taking a short position in the stock. The way I see it, Tesla has so much potential for volatility in the next couple of years, both longs and shorts are playing a dangerous game.
When a friend asked me the other day where I think TSLA’s share price will be by 2019, I told him probably $50. Then I added that if it’s not below $100, it will probably be above $500. Tesla is either going to deliver on its story with a happy ending or it won’t.
A LEAPS Straddle Bet On TSLA Stock
After the conversation with my friend, I got to thinking about the hypothetical $50 or $500 binary outcome for TSLA stock and what could be the best way to create a neutral trade based on that idea. The uncertainty makes long-term options very expensive. But if you agree with my premise that Tesla will be making a major move one way or the other within the next couple of years, it is possible to set up a straddle trade using 2019 TSLA LEAPS.
At a strike price of $220, the Jan 2019 TSLA LEAPS calls last traded at about $57. The $220 puts last traded at around $50. If you invest equally in both options, you will require roughly a $100 move in one direction or the other to break even on your trade. That means that if TSLA ends up above $320 or below $120 by January 2019, you’ve made a profit. If TSLA ends up at $50, you’ve earned a return of roughly 70%. If TSLA makes it to $500, you’ve earned a return of roughly 180%.
Those returns are lopsided simply because the options market appears to be fairly bearish on TSLA stock in the long-term.
If you’re on the fence about which direction Tesla stock is headed in the next two years but agree with the idea that it will be making a huge move in one direction or the other, consider…
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