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Tesla Stock’s Volatility Skew Creates An Ideal Option Trade Opportunity


Tesla (TSLA) is currently sending out conflicting signals. It has been below its 200-day moving average line for nearly the whole year, but it is edging around and slightly above its 50-day moving average line. More importantly, the current volatility skew that Tesla’s stock is displaying is really interesting. Short-term options exhibit low volatility, while long-term options exhibit high volatility. This adds some interest to a longer-term iron condor in this situation.

Why Take This Iron Condor Long Term?
As a reminder, an iron condor can be set up via a combination of a bull put spread and a bear call spread.

The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction.

When it comes to options, we normally look at short-term trades. Anywhere from one week to one month. Selling the longer-term, riskier options for Tesla stock makes more sense, though, as volatility is currently low.

Furthermore, the average movement of longer-term trades is slightly slower than that of shorter-term trades. This provides additional time for adjustment or closure. Nonetheless, the annualized return is reduced as a result.

The fact that longer-term options will be less vulnerable to a possible volatility spike is a bonus.

Tesla Stock Option Trade Configuration
We will begin by setting up the bull put spread in order to prepare the option trade for Tesla stock. We could sell the 130 put and purchase the 120 put by using the Nov. 15 expiry date. The share price of that spread was about $1.65.

The 260 calls were then sold and the 270 calls were purchased, resulting in a bear call spread that traded for about 85 cents. Credits for both premiums are available, so a single iron condor benefits from the trade by an additional $250.

The profit zone falls between 127.50 and 262.50. This can be computed by deducting or adding the premium received from the short strikes.

The maximum risk in the trade is 10 — $2.50 x 100 = $750 because both spreads are $10 wide.

Therefore, the potential return on this iron condor trade is 33% if we divide the premium ($250) by the maximum risk ($750).

Managing The Trade
The iron condor strategy on Tesla stock will perform admirably if price action settles. However, if the price of TSLA stock increases, the trade will lose money.

One can set the stop loss of an iron condor in several ways, depending on the premium received. In this instance, we were paid $250, allowing us to place a stop loss at approximately $375, or 1.5 times the premium.

Sticking to this stop-loss level will help avoid large losses if the trade goes south.

Also, keep in mind the U.S. election is on Nov. five and might bring extra volatility with it. So it might be a good idea to close the trade before then.

According to IBD Stock Checkup, Tesla stock is ranked No. 7 in its group and has a Composite Rating of 40, an EPS Rating of 62, and a Relative Strength Rating of 16.

Please keep in mind that investing in options carries risk and that investors may lose all of their money.

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