Tesla's financial report incoming: how to use sell-side volatility options strategies to seize investment opportunities

Tesla will release its Q2 financial report after the market closes this Tuesday. What are your expectations?

Last weekend, Joe Biden announced his withdrawal from the election, leading the market to anticipate a new round of "Trump trade".

This could temporarily keep Tesla's implied volatility (IV) elevated, making sell-side options strategies still relevant.

This week, I'll focus on two other sell-side strategies: Short Straddle and Short Strangle. These strategies are suitable for the situation that both call and put option prices decline when the stock trades sideways.

Generally speaking, when the stock price rises, the call price rises. The stock price falls, the put price rises.

Frequent options traders may observe the following: when buying a call option, if the stock price drops, the call option price falls as well. However, even if the stock price eventually returns to its original level, the call option price may not recover to the initial purchase price.

This is because the option price contains intrinsic value and time value. Time value can, to a certain extent, represent the market’s expectations for the potential profit of holding the option until expiration.

As time passes, the potential range for significant stock price movements narrows, leading to a decline in the option’s time value.

This phenomenon is particularly noticeable around the time of earnings reports. Before an earnings report is released, implied volatility (IV) is high because there is a greater expectation that the stock price could make significant movements, increasing the time value of the option.

However, after the earnings report is released, if the market does not expect any factors to move the stock price in the short term, the stock price may trade sideways, causing a sharp drop in IV and a rapid decline in the option's time value.

At this point, even if the intrinsic value of the options remains unchanged, both Call and Put option prices will decrease due to the sudden drop in time value.

In this situation, since the holders of both Call and Put options (long positions) would incur losses, their counterparty, the sellers of Call and Put options (short positions) would profit.

As a short seller, you can sell both Call and Put options when their prices are relatively high and then buy them back to close the positions when the portfolio price decreases, thereby earning the difference. This strategy is what we will introduce next: the Short Straddle and Short Strangle.

If you believe that the implied volatility (IV) will decrease from its high levels after the financial report is released, you can construct a Short Straddle strategy.

Assume that the current stock price of TSLA is $248, and you believe that the stock price will experience minimal movement after the financial report is released.

Therefore, you decide to construct a Short Straddle strategy, simultaneously sell one Call option and one Put option at the same strike price.

You choose the strike price that is closest to the current stock price. In this case, you sell one Call option with a strike price of $247.5 and one Put option with a strike price of $247.5.

The total premium for these two options is $30.15 per share, resulting in a total premium income of $3015.

Let's first discuss the scenario where the position is held until expiration. From the P&L curve, it is clear that the strategy is profitable when the stock price fluctuates within the range of $217.35 to $277.65. Conversely, the strategy incurs losses if the stock price moves beyond this range.

In practical terms, the Short Straddle strategy is typically not applied to stocks with consistently low volatility, as the premiums collected would be relatively small compared to the larger potential losses.

Instead, this strategy is more suitable for situations involving an "IV Crush", where implied volatility (IV) drops significantly. During this process, the time value of options depreciates rapidly, allowing you, as the seller of both Call and Put options, to potentially benefit more from time decay.

The two strategies are essentially the same, as both involve selling a Call and a Put simultaneously. The only difference lies in the selection of strike prices: A Short Straddle typically involves selling two at-the-money (ATM) options, whereas a Short Strangle involves selling two out-of-the-money (OTM) options. This means selling a Call option with a strike price higher than the current stock price and a Put option with a strike price lower than the current stock price.

Essentially, a short straddle is a specific type of short strangle. In a short strangle, the wider the strike prices, the larger the profit range but the lower the premium income. Conversely, when the strike prices are equal, you get the smallest profit range but the highest premium income, defining a short straddle strategy.

There is no fundamental difference between the two strategies. In practice, you can construct the corresponding combination based on the trade-off between risk and potential profit.

Alright, that wraps up today's sharing.

The strategies discussed are best suited for scenarios where the TSLA's implied volatility is expected to decrease.

A word of caution: options trading involves risks, particularly for sellers. Selling both Call and Put options entails taking on bilateral risk. For a more conservative approach, you can also choose a single-sided selling options strategy.

If you have other ideas about options seller strategies, feel free to share and discuss them in the comments section.