Here’s a quick options trade idea that might help you add some extra profit when you’ve had a big profit in a stock and it’s about to release earnings.
Let’s say you were savvy enough to buy 100 shares of Tesla (TSLA - Free Report) earlier this year at $500/share. You’ve seen extraordinary appreciation. Thanks in part to speculation that the electric automaker will report a fourth consecutive quarterly profit in Q2 – qualifying it for inclusion in the S&P 500 – those shares are up more than 200% since April.
Production numbers released by the company suggested that revenues would be at least in line with expectations, but the net GAAP earnings number has been the main focus of investors who know that inclusion in the index would mean managers of index funds would have to buy tens of billions of dollars worth of shares of the company to give it the 1%+ weight necessary to keep their portfolios balanced.
You like the stock and you think it’s legitimately the company of the future, selling products that are good for the environment while also turning a tidy profit. It’s expanding production and sales around the world and at the moment, it seems to be eating everyone else’s lunch in the increasingly crowded electric vehicle industry - as well as in battery and home solar technology.
But currently trading at a forward P/E Ratio of 300X and Price to Sales of more than 10X, it’s really expensive by almost any conventional metric…
If it were less expensive, you might consider buying more shares, and if it runs up too much more, discipline would demand that you consider selling and booking your huge gains.
Sell a straddle!
On Wednesday afternoon, the at-the-money 1600 strike calls and puts that expire on this coming Friday were trading for about $110 each.
You read that right - $110. With just two days remaining. The options markets were expecting a big move after the report. That price represents an implied volatility of 230%.
You could sell the straddle for $220, or a total premium of $22,000. Given that you already have an excellent profit in the trade, you almost can’t lose on this trade.
If earnings are a miss and the stock declines precipitously, you get to buy another 100 shares, but at a net price of just $1380 – a 14% discount to Wednesday’s closing price.
If the stock rallies sharply, you’ll end up selling out your 100 shares at a total net price of $1820/share – an unbelievable profit in such a short time.
Either of those circumstances could be classified as a “win.”
Let’s say the stock moves up, but by a modest amount. (Spoiler alert: this is what actually happened after the company reported better than expected net on Wednesday night.) The options you’re short only have two trading days left to expiration and with that big report in the rearview mirror, the time value of those options will evaporate quickly.
With the shares at $1660 – as they are in the extended session Wednesday night – I’d expect the 1600 put to trade at less than $20 and the 1600 call to trade at its intrinsic value, plus that same $20 in premium for a total of $80.
That would mean you could buy back both options in your straddle for a total of around $100 for a profit of $12,000. Or if you want to sell the shares, you could simply let the options expire, and as long as Tesla shares are still above $1600 on Friday afternoon, you’ll realize that $1820 net sales price. That’s a 265% return in just four months.
Sometimes high implied option volatilities are warranted, an indication that a stock really is going to move an extreme amount. When you’re sitting on a big profit however, those high volatilities can be a way to line your pockets with even more cash.
Want to apply this winning option strategy and others to your trading? Then be sure to check out our Zacks Options Trader service.
Interested in strategies with profit potential even in declining markets? Maybe our Short List Trader service is for you.
Want more articles from this author? Scroll up to the top of this article and click the FOLLOW AUTHOR button to get an email each time a new article is published.