Options Strategy: Selling Bear Call Spreads on Tesla
Remember, options can be extremely risky. Option trades can see 50% losses in a few minutes, and selling options can lead to losses greater than 100%. If you are new to options, just read this section for a while before jumping into very small options trades. Consider this a basic primer to get you ready for eventually trading options, even if it’s just to hedge your portfolio.
Selling Bear Call Spreads
One of the less risky option strategies involves spreads, either buying or selling. In this case, I’m going to talk about selling spreads. Selling call spreads implies that you’re bearish on a stock, hence the “bear” term added to the front.
You typically want to sell spreads on stocks with higher IV (implied volatility), because that means there is a higher premium to collect. Extremely stable stocks have very low IV, which means there’s almost no profit to be made in selling premiums.
The one thing to be careful of, is why IV is high for a stock. If earnings are coming up, IV may be high because the stock will likely move up or down 5 to 10% after earnings. In those cases, you likely don’t want to be selling premium, because the stock can move against you very easily.
Let’s take Tesla as an example. Its IV is relatively low historically, but is still a fairly high IV stock (70% IV for near-the-money options expiring on Friday March 26th).
Let’s say that you sell a 710/712.5 call spread. This means you’re selling the $710 strike call (currently priced at $12.20), but buying the $712.50 call for $11.30. You immediately pocket the difference between these two prices, which is $90.
Remember, one option contract represents 100 shares, so the $710 strike represents 100 shares x $12.20 = $1,220. You receive $1,220 but pay $1,130 for the higher-priced strike.
Think of the $712.50 strike as your hedge; if the trade moves against you, you are limiting your losses by holding a strike. However, you severely limit your profit potential by not just selling the $710 strike outright.
The ideal outcome of this trade is that Tesla ends below $710 at the close on Friday. If it does, you keep the $90 premium collected, and both options expire worthless.
The breakeven price for this trade is $710.90. This is because you start to lose money if Tesla closes at $710, but your loss will be offset by the $90 premium collected. Above $710.90, you trade loses money. Your loss is capped at $160, which would occur at $712.50. Above $712.50, your loss is capped by the hedge of owning the $712.50 call.
If you wanted to take the opposite side of this trade, you would simply buy the spread for $90. Your max loss would be the $90 paid, but you would profit if Tesla finished above $712.90 on Friday.