I come to r/investing hoping this post can somewhat explain what’s happening in Tesla, since every day there’s a lot of questions about it. I understand my post isn’t is not the typical r/investing post, but my post is meant to hopefully explain some things the r/investing crowd may not have heavy exposure to, which is options and how they are having a massive effect on certain stocks, particularly Tesla.
So to begin with, I see way too many posts like P/E of stock XYZ is too high. Tesla is one of these XYZ stocks, but the market has changed. No one really cares about P/E anymore. All that matters is supply and demand and especially through options. Unfortunately, because of retail, the entire options market has changed the last few months, which probably changed the behavior of funds too, causing the entire market to change. Here’s a quick explanation using some options terminology of what I see is happening.
Call volume is almost like 90% today and it’s historically skewed towards calls, especially calls that put pressure on the upside skew of the vol curve (which brings in kurtosis). That’s the only thing that matters. If people buy calls -> the stock will keep going up because it’s natural float is so low and big players like Musk and Baron don’t sell to cause any selling pressure.
The equity game has changed to the point most people are now making their bullish bets through options to gain max leverage. If there are a lot of people buying calls, that’s a bullish sentiment and so the stock will go up, just like when people buy a lot of shares. People have to get that in their heads that supply/demand is what drives price moves and options provide a leveraged version of supply and demand.
The calls on Tesla cause the name to explode even more to the upside than a boring name like say an INTC because Tesla comes with the extra special convexity/kurtosis bonus in that if the stock goes up, volatility explodes and gamma explodes. Hence market makers now will have to be desperate to buy as many shares as possible to stay delta neutral to the new skew, causing a feedback loop to bring the stock even higher.
This is also easier to do the lower the stock price, since calls become more affordable to retail. Whether that was Elon’s motivation for splitting the stock or not is unknown, but he’s a smart guy. I’m sure he probably knows.
It could theoretically work in reverse too, going down through the same short strikes it went through, but you would need a major catalyst. A major QQQ selloff or some announcement that’s bad for Elon Musk could trigger a -20% selloff since it does work in reverse, but in a natural market environment, this should not happen.
Simple STRATEGY: The strategy IMO is to buy SHARES. Buying puts is probably a no-no but you could get lucky once in a while with timing. Shorting shares is definitely a no-no unless you want to go bankrupt. Buying calls could be really good if you time it right, but the main issue with buying the calls is you have to buy it at the right vol level. Market makers are not just going to let you run them over, so they will naturally jack up this skew/call IV to a high level where they can win even selling calls and having the stock go up. For example, if Tesla is 490 now and a market maker sold a 600 call and delta hedged it by buying shares, they will win if the stock goes up to 600 even at expiration. The 600 call buyer would actually lose unless he sold earlier. Thus, shares is probably the better play. Nevertheless, the reason for these explosive up moves is explained by options.
If you are uncomfortable with buying shares due to the high P/E and bubble like nature of Tesla, I can understand that. However, you must also understand investing should be more than a financial statement now. You must factor in things like options volume in terms of investing. Using the same mindset, this is why I would never ever invest in a stock like XOM. No retail is going in and buying XOM calls. This can be said about CSCO too. You don’t get that options pressure you want, which is a “fundamental” reason for a stock to go up. So if you don’t like Tesla since it is indeed a high P/E, you can apply this same idea and buy Apple (or Microsoft) then. It’s a lower and reasonable P/E, has similar call option volume flow, and is a much better long term investment than XOM or CSCO.
Submitted August 31, 2020 at 02:37PM by BuffettGOAT https://ift.tt/3gLgNlC
