Option structures can earn income and limit risk
Tesla is the only MAG7 name down in 2024 as of May 3, and some investors see more downside based partly on a high valuation and growing competition from cheaper electric vehicles – but also perhaps due to Elon Musk’s controversial media statements that may upset both investors and customers. There has also been a successful shareholder lawsuit in Delaware that wiped out the USD 55 billion package awarded to Elon Musk in 2018. Musk is appealing, and also seeking to redomicile Tesla in Texas.
The problem with shorting Tesla in a linear fashion has been huge rallies. Between the start of 2020 and the end of 2021 the stock went up more than tenfold. A short seller who did not rebalance the position could have lost 9 times their initial short exposure, but would probably have closed it much earlier due to margin calls. A short ETF that typically rebalances daily would have lost over 95%, and a leveraged short ETG even more.
Therefore, Yield Max ETFs has created a new product with ticker CRSH that offers some degree of potential to profit from a lower Tesla share price, but with limited risk, while generating ongoing income.
It uses a mix of put and call options. The puts can increase in value if Tesla’s share price falls, but cannot lose more than the cost of the put option. In addition the product buys call options above the current Tesla share price, which could profit if Tesla crashes upwards, but again cannot lose more than the cost of the call options.
In fact, the strategy is more sophisticated than that because both the calls and the puts form part of spreads, which are also designed to generate some income from the option premiums. Some options are being sold to generate income, including from selling upside, and also reduce the potential profit from the options that are bought.
Since options provide a form of leverage, a small amount spent on option premium provides a lot of “bang for your buck” and most of the portfolio is not spent on options. The current portfolio breakdown shows that over 90% is currently sitting in US Treasury bonds, which also provide some income.
This is quite a complicated strategy, with a mix of bought and sold, call and put options, and its performance will also depend on how the option spreads are actively managed. At any point in time, modelling will show a non-linear return pattern from different moves in the Tesla share price. And over time the option structures will change - they could be rolled up or down, before or after they expire, to higher or lower share prices in response to the Tesla share price movement.
The product is certainly worth monitoring and researching further for investors who want to find a different way to express a bearish view on Tesla, with limited risk and some income.
