By: Costas Bocelli — May 8, 2019
David Einhorn, hedge fund manager and founder of Greenlight Capital makes no qualms about his feelings towards Tesla (TSLA) and its controversial CEO Elon Musk.
At the Sohn Investment Conference, an annual conclave where high profile fund managers volunteer to present their latest investment ideas to help raise money for charities, Einhorn called Musk’s promises for the future prospects of Tesla “a lot of horsesh*t”.
He then presented a few slides, one of them featured an unflattering picture of a “poop” emoji pasted over Musk’s face.
Einhorn and his hedge fund are betting huge against Tesla by shorting the stock.
Shorting, also called short-selling, is when an investor borrows a security (in this case shares of TSLA stock) and immediately sells them, hoping that they can be bought back later at a lower price so the seller can pocket the difference.
Having the ability to play both sides of the market (taking bullish and bearish positions) is a major advantage for professional investors.
In Einhorn’s opinion, TSLA is overvalued and fundamentally flawed, so he’s taking a bearish position by shorting the stock.
Tesla has never turned a profit in a fiscal year.
Tesla also has $8 billion in debt on its balance sheet…
…and that debt is growing.
The company recently secured another $2.7 billion in financing through an offering of stock and convertible notes, giving the electric car maker a much-needed cash infusion as it ramps up production.
With the current stock price around $249.00 per share, TSLA has a market capitalization of $43 billion.
Einhorn believes that it’s an absurd valuation and that TSLA will not be able to meet or exceed the market’s expectation, ultimately sending the stock lower.
(Click any image to enlarge)
Now here’s the thing…
Not everyone is bearish on TSLA.
In fact, there are many investors that are on the other side - like Ron Baron, fund manager and founder of Baron Capital.
He’s been a long-time bull on TSLA and thinks that the market valuation will be much, much higher in the future.
We can go on and on as to debating the fundamentals of Tesla.
But that’s not the case when we look at the technicals on TSLA.
You see, if you simply look at price, TSLSA is indeed a real “stinker” of a stock!
If you refer to the accompanying daily price chart in TSLA, you’ll find that its longer-term trend is negative. The stock is also trading well below its 200-day moving average (blue line), another popular indicator of trend.
The stock has also been trading in a declining trend channel over the past six-months (red-dotted line), making a series of lower highs and lower lows.
The stock recently broke below the prior lows of April 2018 and October 2018, which can be considered a key area of support.
In terms of its relative strength, the stock is also underperforming the broad market and its peers in the Autos & Parts sector.
Here is snapshot of the relative characteristics of TSLA using the Position Key feature in Sector Prophets Pro, our data analytics product.
Looking at the technical picture, we would have to agree with Mr. Einhorn that TSLA is deserving of the “poop” emoji.
How Individual Investors Can Short TSLA
If you agree with Mr. Einhorn’s thesis, that TSLA stock will continue to trade lower, short selling may not be the most suitable way to make a bearish bet as an individual investor.
Shorting stocks in a regular customer account (as opposed to a professional broker-dealer account) can be fairly costly.
Shorting stocks also carries the potential for unlimited losses should the stock rise and not fall.
And short selling in a qualified retirement account (such as an IRA) is prohibited.
All of these reasons are why most individual investors shun making bearish investments, even when there seems to be a great opportunity to make a profit.
The good news is that we have a perfect solution to all of these issues:
By Purchasing Put options, you can make a bearish bet and profit in a similar fashion as a professional investor would do by selling short the stock.
And even better, Put options can be purchased in an IRA. That means you can use your retirement account to play both sides of the market, just like a hedge fund.
Put option buyers have the benefit of limited risk (you can only lose what you pay for the option) and are less capital intensive than shorting the underlying stock.
Here’s How it Works
Let’s use TSLA as an example of how to use Put options to make a bearish bet that the stock will continue to trade lower.
With TSLA trading $248.90, you could purchase the August 245 Put option for $25.00 or $2,500 per contract. Each Put option contract gives you the right to sell 100 shares at $245 (strike price).
Tesla is expected to report Q2 earnings at the end of July, so the Put option will capture the earnings event. TSLA typically makes a big move following the announcement so if you are expecting the stock to trade lower, a negative reaction in the market will be your “ticket”.
And because TSLA is volatile around earnings the option premiums are relatively expansive.
In this case, you could look to reduce the cost of your bearish bet by selling a lower strike Put option against it, thus creating what we call a Put Spread.
Investors could construct the Put spread by selling the August 210 Put option for $12.50, which reduces the cost of the bearish bet by about half.
The trade-off for cutting the cost in half is that the profit potential would now be limited, down to $210.
Buying Put options and Put spreads can be an effective way for individual investors to play the downside and a viable alternative to short selling directly in the underlying stock.
In Options Soup, our options educational program, we show investors exactly how to use Put options and Put spreads to profit from the downside, just like a hedge fund manager. To learn more about Options Soup, call 855-822-0269.
Until next time!