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As Tesla Volatility Ebbs, Take profit and Reduce Risk

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Last week we discussed an options trade in Tesla (TSLA - Free Report) that had the potential for significant profits if the company surpassed expectations when it reports Q3 results in November.

We purchased one NOV 350 call and sold two NOV 400 calls for a debit of $5.50 and the p/l profile looked like this:

Since then we’ve seen significant news events that have moved Tesla shares significantly in both directions.

First, the stock declined precipitously on the news that the SEC had filed a lawsuit that accused CEO Elon Musk of fraud in association with his “funding secured” tweet. Last Friday the shares traded as low as $261.

Then, over the weekend, it was announced that Musk and Tesla had reached an agreement with the SEC that allowed him to pay a fine, neither admit or deny guilt and remain CEO. The shares erased the losses from the previous week, closing at $310.70.

This week, Tesla announced that they had met estimates for production and deliveries of Model 3s, but also noted that headwinds in China were making their vehicles 55-60% more expensive than comparable Chinese vehicles.

Tesla shares have trended lower and are currently trading at $285/share.

There’s still a month to wait until the Q3 earnings report, but our thesis remains the same.

If Tesla has been able to achieve gross margins greater than 20% on the 53,000 Model 3s they delivered in the third quarter and especially if they can post a net profit for the quarter, the shares are likely to rally.

Thanks to the recent selloff – and a decline in implied volatilities - the 400 calls we are short are now trading $1.00. If we buy one of them back, we will own the 350-400 vertical call spread with upside potential of $43.50 and our risk will be limited to the $6.50 in total premium we’ve paid.

The new risk profile will look like this:

A significant improvement!

Though the original trade has changed in value significantly in both directions since we initiated it a week ago, the disciplined approach is to use current market conditions to reduce the risk while preserving the potential for significant profits.

Buying back one of the calls that we are short turns the position into a “set it and forget it” trade that we won’t have to pay much attention to, but will still reward us handsomely if Tesla turns in a strong quarter.

Often, a trade doesn’t go immediately in your favor as soon as you put it on, but it’s important to continue to pay attention to ways to adjust the position to improve your odds.

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