2 Unusually Active Tesla Call Options. Only 1 Is a Buy

Tesla (TSLA) reported earnings Wednesday after the close of trading. The news was good, with both earnings and revenue beating analyst estimates. As a result, its shares were up more than 10% in Thursday's pre-market trading. 

In yesterday’s options trading, Tesla had two call options exhibiting unusual options activity that expire on the same day: March 15/2024, 413 days from now. 

Only one of them is a buy. Here’s why. 

A Higher Strike and Lower Ask

Anyone who’s read my options-related articles on Barchart.com knows that I’m an admitted rank amateur regarding these little critters. Instead, my strength lies in evaluating a company’s business model, strategy, and financial strengths and weaknesses. 

That said, options are an excellent way to dip your toe into stock ownership. 

If you think you want to buy Tesla, a call option contract allows you to make a down payment on 100 shares with a much lower initial investment. For institutional investors, options have become an essential tool in the portfolio manager’s toolbox to increase returns while lowering risk.  

But I digress. 

The first call option from Wednesday’s trading I’m looking at had a $241.67 strike price with a $1,235 premium. So, in this case, you’re making a 5.1% downpayment on 100 shares of Tesla stock with more than a year until expiry. 

Add the $12.35 ask price on top of the strike, and Tesla’s got to get to $254.02 to break even. Based on its Wednesday closing price of $144.43, it must increase in value by 76% over the next 59 weeks. 

I guess that’s doable. 

Between March 2020 and January 2021 (13 months), TSLA stock jumped nearly 2,000%. Between May 2021 and November 2021 (7 months), it more than doubled in value. So it’s got a track record of delivering fantastic returns for patient investors. 

However, yesterday’s news came with a but!

The company’s automotive gross margin in the quarter was its lowest (25.9%) in five quarters--and it’s not likely to get any better in the year ahead as Elon Musk sacrifices profits for revenues and a shot at two million vehicles in 2023. 

Gross margins could get much worse before they get better. 

“‘Most notably, these margins were before the real price cuts kicked in earlier this month,’ the analysts added. ‘With ~10%+ incremental price reduction YTD, auto gross margins ex-credits could certainly be sub-20% for some quarters in 2023 (given the price cuts point to a $5000+ reduction in gross profit dollars sequentially),’” Investing.com reported Bernstein analyst comments on Thursday. 

Last time I checked, stock prices followed earnings. 

A Lower Strike and Higher Ask

The second March 15/2024 call option had a $110 strike price and a $56.60 ask. The first call’s delta was 0.030183, while the second was more than double at 0.79420. Based on these numbers, the first call’s share price has to rise by $41 over the next year to double the return on the premium, while the second has to jump by $71 to double. 

So, on the surface, the first call is the better option for two reasons. First, the shares will only increase by slightly more than 28% over the next 413 days. Secondly, the down payment for the first call was a little more than 5% compared to 51% for the second. 

Alternatively, the $241.37 strike (40% out of the money) could be viewed as the nag expected to trail the field, while the $110 strike (31% in the money) would be a stakes-race winner.

If you’re bullish on Tesla stock in 2023 -- the 45 analysts that cover Tesla, according to MarketWatch, rate it Overweight with an average target price of $210.63 -- paying a $5,660 down payment to be 31% in the money as opposed to $1,235 to be 40% out of the money makes some sense. 

That’s especially true when you consider that Tesla finished 2022 solidly, delivering a lot of positives, with production set to pick up for the Tesla Semi, which began deliveries this past December. 

However, that was yesterday. 

Today, the $241.67 strike has an ask of $15.40, 25% higher than Wednesday, and five contracts traded, while the $110 strike’s ask is $66.00, 17% higher, with zero volume in morning trading.         

Bottom line: It’s a really tough call. The higher strike is the less appealing play if you intend to exercise the option and own the stock, whereas if you’re looking to make a little profit by selling the call before its expiry, the higher strike is the better play. 

If it were me, I’d go for the higher strike, saving $5,060 [$6,600 less $1,540] for a less volatile stock to own for the long haul. 

Either way, following Tesla in 2023 is bound to be exciting. Elon will make sure of it.

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