Tesla has had a tumultuous few months. First, a 50% drop over a few weeks, followed by a 100% gain by Tesla stock to end right back where it was in early December. After a period of such wild swings, maybe it's time for the stock to settle down and consolidate around this level.
Tesla stock also is trading in between the 50- and 200-day moving averages. So if traders think that rangebound trading may occur, that could mean it's a good time for an iron condor option trade.
Implied volatility is still relatively high at 69% compared with a 12-month low of 49% and a high of 96%.
This factor also makes the iron condor an attractive trade in Tesla stock.
To review, an iron condor combines a bull put spread and a bear call spread. The idea with the trade? Profit from time decay while expecting that the stock will not move too much in either direction.
Tesla Stock Today: An Iron Condor Trade
First, we take the bull put spread. Using the March 17 expiry, we could sell the put option with a 160 strike price, then buy the 155 put. That spread could be sold yesterday for around $0.80. Then take the bear call spread, placed by selling the 255 call and buying the 260 call. This spread sold on Tuesday for around $0.45.
That's quite a wide iron condor and should have a good chance of success. In total, the iron condor will generate around $1.25 per contract, or $125 of premium.
The profit zone ranges between 158.75 and 256.25. You can calculate this by taking the short strikes and adding or subtracting the premium received.
As both pairs of options show a spread of $5, the maximum risk in the trade is 5 minus 1.25, or 3.75, multiplied by 100 to get $375.
Therefore, if we take the premium ($125) divided by the maximum risk ($375), this iron condor trade in Tesla stock has the potential to return 33.3%.
How This Trade Makes Money
If price action stabilizes, then iron condors will work well.
One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $125, so we could set a stop loss equal to the premium for a loss of around $125.
Another way to manage the trade: Set a point on the chart where the trade will be adjusted or closed. That could be around 175 on the downside and 235 on the upside.
According to IBD Stock Checkup, TSLA stock ranks fourth in its group. It has a Composite Rating of 64, an EPS Rating of 99 and a Relative Strength Rating of 13. However, the 3-month RS Rating of 94, as noted in MarketSmith's Technical Panel, highlight's Tesla's recent strong rebound.
A few weeks ago we looked at a bull put spread held over earnings, which returned 14%. Hopefully this new trade will be as successful. Please remember that options are risky, and investors can lose 100% of their investment.
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
