Turning the Tables on Tesla's Decline: How Options Can Save Your Investment

On October 11th, Tesla's stock price experienced a significant drop of over 8%. This volatility followed the company's presentation the previous evening, which showcased two innovative electric vehicles: the Cybercab and the Robovan. The market's reaction suggests that these presentations may have fallen short of expectations, leading to a notable decline in stock price post-event.

For investors who had high hopes for the presentation and bought Tesla stock beforehand, the current holding experience might be less than ideal. From the peak price on October 10th to now, potential losses could approach 10%. In such situations, besides patiently waiting for market recovery, investors can consider using options as a financial tool to effectively manage risk and potentially offset or reduce losses from stock depreciation.

Let's illustrate this with an example. Suppose you purchased 100 shares of Tesla at $240 per share on October 10th, but now the stock price has fallen to $220. If you're optimistic about Tesla's future, and are willing to hold these shares long-term, but don't expect the stock price to rebound to $240 in the short term or anticipate any surprises in the upcoming earnings report on October 23rd, you might consider employing a covered call strategy to lower your holding cost.

The covered call strategy might sound complex, but it's relatively straightforward. For instance, you could sell one Tesla call option expiring on November 1st with a strike price of $240. This combination of your 100 Tesla shares and the sold call option constitutes a covered call strategy, and you'll immediately receive a premium for selling the option, approximately $460.

This investment could face the following scenarios at option expiration:

1. If Tesla's stock price rebounds but remains below $240, the option won't be exercised, and you'll keep the $460 premium. For example, if Tesla's stock price recovers to $230 by November 1st, your stock loss would be $1,000, but with the $460 option premium income, your net loss would be reduced to $540.

2. If the stock price rises above $240, the option is likely to be exercised, forcing you to sell the stock at the $240 strike price. While you'd miss out on further stock price gains, the option premium helps offset some of the loss. For instance, if Tesla's stock price rebounds to $240 by November 1st, you'd sell the stock at $240, resulting in no gain on the stock itself, but you'd keep the $460 premium, for a total profit of $460.

3. If the stock price remains below the strike price, you could continue to implement similar covered call trades to accumulate option premiums and offset some of your investment loss. Assuming you execute a covered call trade monthly, each time earning a $460 premium, after 12 months, even if Tesla's stock price still hovers around $220, your cumulative option premium income would be $5,520. With a stock loss of $2,000, after deducting the option premium income, you'd end up with a net profit of $3,520. It's important to note that the premium income from selling call options isn't always this high each month; it depends on the stock's potential volatility.

The risk of the covered call strategy lies in the fact that it usually requires investors to hold a substantial number of shares, as one standard call option contract in the U.S. stock market represents 100 shares. For Tesla, this means you need to hold at least 100 shares to sell one call option, which is worth over $20,000. Furthermore, the premium income gained through the covered call strategy comes at the cost of forfeiting potential gains if the stock price exceeds the strike price. For example, if Tesla's stock price surges after the earnings report and reaches $300 by November 1st, you'd still have to sell these 100 Tesla shares at the $240 strike price, missing out on $60 per share in potential gains. Therefore, the covered call strategy is best suited for investors willing to hold stocks long-term but not expecting significant short-term price increases.

In conclusion, while buying stock just before a significant drop can be disheartening, using options strategies like covered calls can provide a way to potentially mitigate losses and even turn the situation around. This strategycan be applied to other stocks facing unrealized losses as a means to reduce costs and potentially improve returns. However, it's crucial to emphasize that investors should never engage in naked call selling. If the stock price skyrockets, the potential losses from naked call options are theoretically unlimited, which could lead to devastating financial consequences. Always ensure you own the underlying stock when implementing a covered call strategy to limit your potential losses.