The Tesla Time Spread

Who doesn’t like to buy less expensive stuff and sell more expensive stuff? Everyone loves buying stuff on sale, especially if they can turn around and sell it for a higher price, right? In fact, I can honestly say if you don’t like buying less expensive and selling more expensive things then you’re going to have a difficult time making money in the options market! Perhaps that’s the case already and you are already struggling to make money. There are ways to maximize your potential reward/risk in an option structure by taking advantage of volatility skew. This post in going to examine a potential trade in Tesla (TSLA) and the opportunity afforded by the favorable IV skew.

Typically volatility skew (option skew) refers to the fact that implied volatility (IV) is higher for OTM options strike prices than ATM prices for a given expiration date. That applies to Puts much more often than Calls but in this post I’m going to ask you to set that definition aside as I’m going to refer to option skew as simply the difference between the front and back expiry of a time spread. In a typical time spread, such as a Calendar spread, the front expiry option is sold and the back expiry option is bought. That’s where this post is headed but first I’ll show you the chart that I’m using to determine the target price area in the trade.

Below is the daily chart of TSLA. Clear downtrend but punctuated by strong counter-trend rallies. I’m not going in-depth on the price analysis since this post is about the option structure but you can see that I’m simply targeting the 50%-61.8% Fib retracement of the prior decline. It’s very possible that, if price continues the current rally at the current pace, the 207-233 target area could be reached within the next 1-2 weeks.

Below is a risk profile showing 5 different Calendar spreads with the top one, the Feb3/Feb10 TSLA 220 Call Calendar selected. That Calendar features a trade skew of 23.76% (technically it’s -23.76 but I’m going to stick to positive numbers to avoid confusion). That means I’m selling much more expensive IV than I’m buying. That makes the cost of the Calendar relatively cheap. Cheap is good!

As mentioned, in the risk profile above I’m showing different expiry’s so that you compare the cost of the different Calendars. It would cost $1.10 to buy the Feb3/Feb10 Calendar. For an additional $.95 I can buy the Feb3/Feb17 Calendar. Is it worth an extra $.95 to have another week of duration for the long option? I think so but you can decide for yourself.

Below is the risk profile of the Feb3/Feb24 TSLA 220 Call Calendar. That would cost $2.65. Quite a bit more expensive than the Feb3/Feb10 but it gives me the ability to potentially let the Feb3 short Call expire worthless if price hasn’t reached 220 by Feb3 and then sell the Feb10 Call to bring in a credit. If the Feb10 also expires worthless (or I buy it back for a few cents) then I can sell the Feb17 Calls to bring in another credit. It would be very possible by then that the credits I will have received for those ‘rolls’ could easily exceed the original cost of the Calendar. That would lock-in a minimum profit and still allow for a very large profit if the price of the stock is near 220 at Feb24 expiry.

Below is the final risk profile I’m going to discuss. That Calendar is short the 220 Call in Feb10 expiry and long the 220 Call in Feb24 expiry. Pretty cheap overall for a price $1.25 and with a large potential reward/risk.

As you can see I showed 5 different Calendars on the risk profile but only discussed 3 of them. The rest of that analysis is up to you! I’m willing to point you in the right direction but I’m not going to do the work for you! The way you’ll really learn this is through trying lots of different potential trades. You can change the expiry dates that I’m showing to compare costs. You can change the strikes of the Calendar to move the position up or down. You can change the Calendar into a Diagonal spread to add Deltas (long Diagonal) or reduce Deltas (short Diagonal). The most important takeaway from this post is that, in this situation, a time spread is a very good choice for trading Tesla at the current time due to the favorable option skew.

Update: Because I’m short term bullish, longer term bearish based on the TSLA chart I can trade those as separate events or I can combine them in 1 position. I could keep the Feb10/Feb24 220 Call Calendar (or any other calendar shown above) and add to it the Jun16 115/100 Put Vertical Debit spread. If I combined those 2 trades into 1 position the initial Delta risk would be just -.14 Deltas. That’s equivalent to being short about 10% of 1 share of Tesla stock! IF TSLA moved higher over the next few weeks the trade should be profitable and if, instead, TSLA moved down quickly the Vertical spread would reduce or even eliminate a loss on the Calendar spread. One final note, risk profiles are estimates based on the current Greeks. It’s entirely possible that the outcome of either or both trades will differ from what the risk profile shows currently.

2/2/2022 Update: I actually ended up buying the Feb10/Feb24 TSLA 210 Calendar spread for $1.80 Debit on 1/30. Price initially went lower for a day after the trade but then turned up and rallied up to 194 where I rolled the short Feb10 210 Calls out 1 week in time. I was able to collect a $1.90 Credit for that roll so that took my net cost to a $.10 Credit for owning the Feb17/Feb24 210 Call Calendar. Below is the risk profile and the order fills.

Questions or comments, leave them down below.