The 16% rally in the Nasdaq composite from its March 14 bottom pales to the nearly 50% rise in Tesla (TSLA) during that time. Does it keep going from here or take a pause for a little bit? If you think a pause is likely in Tesla stock over the next few weeks, here’s an option strategy that can return 59%.
Iron Condor On Tesla Stock
According to the IBD Stock Checkup, TSLA stock is ranked No. 1 in its group and has a Composite Rating of 97, an EPS Rating of 74 and a Relative Strength Rating of 95. As strong as the numbers are, and its recent rise, a consolidation of gains may be in order here.
When a stock trades with high implied volatility, that’s usually a good time to “sell premium” for options traders. That’s what an iron condor option trade does. It combines two credit spreads, a bull put spread and bear call spread.
The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction. Perfect for an orderly consolidation.
Since implied volatility is still quite high in Tesla stock, the iron condor can be placed further out-of-the-money to give the trade a higher chance at success.
First, consider the bull put spread. Using the April 14 expiry, if we sold the 1000 put and bought the 995 put, that brought in $1.20 per share in premium as a credit yesterday.
Then the bear call spread. Selling the 1225 call and buying the 1230 call, with the same April 14 expiration, sold yesterday for around $0.65.
In total, this iron condor on Tesla stock generated around $1.85 per contract or $185 of premium.
Profits And Risks
The profit zone ranges between 998.15 and 1226.85. This can be calculated by taking the short strikes at 1000 and 1225 and then adding or subtracting the premium received.
Both credit spreads on this TSLA stock option trade are $5 wide. That’s what we’ll use to calculate the risk. You take that distance between the strikes and subtract the premium received to get your maximum risk. In this case, 5 – 1.85 x 100 = $315 capital at risk.
This a risk-defined trade so $315 per contract is the most you can lose on this iron condor. That occurs if Tesla stock trades outside your long strikes at 995 and 1230 at expiration.
If we take the premium ($185) divided by the maximum risk ($315), the Tesla stock iron condor trade has a potential return on risk of 59% in a pretty short period of time.
Managing the Trade
If price action stabilizes, then iron condors will work well. Time decay and lower implied volatility will decrease the value of the spreads in Tesla stock. That allows you to cover the trade by buying the spreads back for a cheaper price. Or you can achieve maximum profit if they eventually expire worthless. That occurs if Tesla stock is between the short strikes of 1000 and 1225 at expiration.
What if the trade goes against you and the spreads increase in value? You can still protect yourself from taking the maximum loss. One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $185, so we could set a stop loss equal to the premium for a loss of around $185.
Another way to manage the trade is to set a point on the Tesla stock chart where the trade will be adjusted or closed. For instance, you could use 1050 on the downside and 1175 on the upside.
Please 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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