The benefits of a butterfly spread on Tesla

Tesla – the word alone triggers all sorts of emotions these days. Love it, hate it, or wait and see how it all plays out, the chart shows that market participants are willing to remain invested for the long term. Tesla (TSLA) has firmly positioned itself in the growing field of artificial intelligence since the automaker's inception. As Tesla stock approaches a new buy zone, traders may be wondering how to participate in the ongoing uptrend while limiting risk.


Tesla stock and the AI ​​trend

There are several tools for this in the options toolbox and the one I'm going to pick today is the butterfly spread with calls. This position provides leverage that can be adjusted if a chart holds (or loses) key price points. Tesla stock ranks 6th within the automaker industry group in the IBD Stock Checkup and has a composite rating of 81.

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Tesla stock is another example of using technical analysis to find ideal buying opportunities. I prefer breakout stocks that retrace a key uptrend support line. This retest of rising support requires a bit of history for TSLA stock as market participants reached breakout levels from 2020 onwards. You can confirm this on a monthly chart with a simple 50 month moving average line.

With founder Elon Musk reaffirming his commitment to improving artificial intelligence, Tesla stock is ideally positioned for traders to continue its uptrend.

Understanding the Long Call Butterfly Propagation

When risk and reward need to be well balanced in a stock, the butterfly allows traders to forego part of the reward in order to set a clear limit on risk.

  • Buy to open 1 TSLA on July 21 with a 210 monthly strike call at 9:25 p.m
  • Sell ​​to open 2 TSLA on July 21st with a monthly strike price of 230 at 12.60
  • Buy to open 1 TSLA on July 21st with a monthly strike call of 250 at 7:30am

The total charge issued is 3.50 per spread or $350. That's also the overall risk to the Tesla stock butterfly. There are two break-even prices (before commissions). On the downside at 213.50 and once above 246.50 on the upside.

The maximum return is achieved when TSLA stock finishes at 230 at expiry. The maximum return is calculated as follows: The difference in strikes (230 – 210 = 20) minus the premium paid for the position (20 – 3.50 = 16.50).

For comparison, buying the TSLA call of July 21 at 210 would cost 21.25 and the breakeven price would be 232.25, much higher than our butterfly position. Granted, we forego some probability of outsized gains, but if TSLA stock is not performing at optimal levels, we can still benefit from exposure.

trade management

Identify the most important diagram levels.

The monthly retest of the 50-month simple moving average near 165 is important. Since then the chart has been moving north and is now retesting the $200 level with the next build up of resistance at 230. This is a well-known retracement pattern for this stock when looking at the monthly candles.

TSLA Stock Butterfly Spread Scenarios

What could happen:

  • Tesla stock goes up to $230 at expiry and we take the full profit.
  • TSLA stock is falling but remains on higher lows and climbs above $210 but not much higher. This allows the butterfly to retain some value, but as the expiration date nears, within two weeks, we will have to re-evaluate. We either cover the position at a loss of less than 50% of the original premium or select the trade by selling options below the 210 price point.
  • If Tesla stock moves significantly down for three days without rising on heavy trading volume, it is a signal that we need to exit the position.

Set an alert for prices on the margins (near 200 and 230). When they do trigger, give the trade a few days to play through and then make your decisions based on your own risk profile.

As with all trades, you should first consider what you like about holding the position and carefully consider your risk.

Anne-Marie Baiynd is a 20-year veteran stock, options and futures trader and the author of The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology. She holds no positions in the investments she writes about for IBD. You can find her on Twitter and Stocktwits at @AnneMarieTrades

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