TSLA Options: Are Call Spreads the Future?

I'm going to keep this post very brief. I may have finished my MBA, but there are a lot of things in my life that I'd like to spend time on that are not Tesla and investing.

Nonetheless, I'd like to take some time to share this research I've done over the past week into Tesla options. More specifically, research into Tesla call option spreads.

I've never been a huge fan of them in the past, because I've always calculated my options returns in # of shares. I still plan to be fully invested in TSLA for the foreseeable future as I explained in detail in My Tesla Investment Thesis 3, so any deviation in investment strategy from owning 100% TSLA common stock, I need to compare to that strategy, so I need to calculate the return on option trades in # of shares. I've talked about this in more detail in My TSLA Investment Strategy, but for the purpose of this post you need to know that a large run-up in the stock beyond the shorted call option means your trade's returns suffer a lot.

There are some other subtle downsides that I'll cover in more detail later, but let me share with you some numbers first.

TSLA 2023 Forecast

Although some of my past predictions have turned out quite accurate:

Prediction in Sep'19 for Q2 or Q3 2021: 225k deliveries, $13B revenue, ~$1B EBIT

Actual: 200-250k deliveries, $10-12B revenue, $1.3-2B EBIT

Prediction in May'20 for Q4'21: $1.75-3.1B EBIT

Actual: $2B in Q3'21, on track to be $2-3B in Q4'21

The following may or may not be as accurate. I think there's less detailed information available than a few years ago, because Tesla has shared less details with investors since the end of 2019, and I also have not followed Tesla as closely this year, so I may have missed some information.

Regardless, this is about where I expect Tesla will end up in the 2nd half of 2023:

Mid case model:

PDF

Excel

Numbers

Bear case:

PDF

Bull case:

PDF

Bear case

Mid case

Bull case

Extrapolated EBIT:

Bear - $20B

Mid - $26B

Bull - $34B

SP @ 50x Extrapolated EBIT:

Bear - $900

Mid - $1,150

Bull - $1,450

SP @ 100x Extrapolated EPS:

Bear - $1,400

Mid - $1,800

Bull - $2,350

Putting that all together, here are my personal confidence intervals for TSLA's stock price in the second half of 2023:

90% CI:

$1,200 - 3,600

75% CI:

$1,500 - 3,000

Basically, I'd be very surprised if it's not at least around $1,200, I think it'll most likely be around $2,000, but there's some chance it could go higher faster.

TSLA Options Comparison

Data in this section is based off of Friday's closing @ $932.57.

First off, here are the pay-offs for naked Jan'24 call options.

And here are the pay-offs for call spreads short the $2,475 call.

Option Spreads Analysis Spreadsheet:

PDF

Excel

Numbers

You can play around with this spreadsheet yourself. You should only have to edit the highlighted fields. This is a similar spreadsheet to the one I shared in My TSLA Investment Strategy blog post. You can find more details about how it works there.

I think the best way to look at this data is by comparing naked calls with a spread that has a similar breakeven point. For example, the $600 call and the $900 spread both more or less break even at a stock price of $1,200.

$900-2,475 spread:
Lose all @ <$900
Breakeven @ $1,200
Max profit 150% @ $2,500
Still profit 70% @ $3,600

$600 naked call:
Lose all @ <$600
Breakeven @ $1,200
Profit 70% @ $4,000

One more example is the $1,100 call and the $1,400 spread that both break even at a stock price of $1,600.

$1,400-2,475 spread:
Lose all @ <$1,400
Breakeven @ $1,600
Max profit 230% @ $2,500
Still profit 130% @ $3,700

$1,100 naked call:
Lose all @ <$1,100
Breakeven @ $1,600
Profit 130% @ $4,000

Below their breakeven points, the naked calls outperform the spreads, because the drop off of the spread is much steeper. However, as long as at least the break even point is reached, the spreads vastly outperform the naked calls, unless the stock goes completely parabolic.

Even if you expect the stock to go to $3,000 by late 2023, even though you lose some money shorting the $2,475 call, putting the premium from that short into a larger number of overall contracts allow the spreads to outperform the naked calls.

Spreads Downsides

There are a few downsides to spreads, but they can more or less be summed up as: expect to get slightly better pay-offs on your naked calls and slightly worse pay-offs on your spreads.

Basically, unless you plan to hold these instruments until actual expiration, there will be some time premium left on the options. In the case of naked calls, this works to your advantage, because you'll get slightly more money when you sell them. However, the spreads are hurt by the time premium left outstanding, because the premium will be higher on the higher strike call you have to buy back, and lower on the lower strike call you are selling. Hence, the net result is your return will be slightly less.

This effect is larger the more time remains till expiration, hence you're probably not going to want to sell the spreads until <6 months before expiration. So if the stock somehow runs up to $2,500 by October 2022, you'll be stoked holding the naked calls and you can take profits, but your happiness holding the spreads will depend on what you think will happen over the next 9-15 months, and taking profits at that time will mean settling for lower returns.

You also have to trade a higher $ value with market makers, who take a small percentage off of each trade by not buying/selling at the midpoint. Both the money spent on the long call and the money received from the short call is subject to this.

So there are some downsides, and I'd expect the naked call returns to be ~5% higher than indicated, whereas most likely spread returns are going to be 10-15% (or more if sold very early) lower.

Conclusion

In spite of the downsides, I think these $xxxx-2,475 call spreads are decent bets right now with TSLA being where it's at. So I started a position on Friday in $700-2,475s and a much smaller one on Monday in $1,050-2,475s.

However, I am wary of the fact that there is a lot of uncertainty right now:

• Omicron
• Inflation
• FED rate hikes
• Changes to QE
• China weakness
• On-going semiconductor shortage and other supply chain issues
• Some Tesla specific execution risks due to new technologies (4680s, castings, structural batteries, Cybertruck, Semi)

All in all, I am both aware that there will likely be better opportunities to buy/leverage up in 2022, but also that there is a small possibility that there won't be.

As always, all options are inherently very risky. Losing 100% of the 'bet' is a possible outcome. What's right for one person is not right for everybody. And I'll certainly turn out to be wrong about at least a few things in this post. TSLA options will never be the same as they were in 2019 and early 2020. Be careful when making your own decisions.