Question about in-the-money puts versus ATM

[Libs]

I'm sure the answer is obvious, but I couldn't find a satisfying answer with a search. Obviously I'm an options neophyte.

 

Example: Tesla stock price is $157. The April 26 $175 puts cost $20. Meaning I need the stock to be at 175-20= $155 to break even. A $2 drop from the current price. Right? 

 

Meanwhile, the April 26 $157 puts (ATM) cost $8...which is a $149 break-even price...now you need the stock to drop $8 to break even.

 

What am I missing? Aren't the $175 puts a much better deal? 

[Sweet]

You aren’t missing anything, it is a ‘better deal’ and it’s somewhat safer too.

 

However if Tesla the $157 puts cost less to own the same amount.

[Libs]

1 hour ago, Sweet said:

You aren’t missing anything, it is a ‘better deal’ and it’s somewhat safer too.

 

However if Tesla the $157 puts cost less to own the same amount.

 

Can it be that simple? I thought the options market was a lot more efficient than that. 

[Sweet]

2 minutes ago, Libs said:

 

Can it be that simple? I thought the options market was a lot more efficient than that. 

Efficient for who though?

 

You’re thinking of it as a buyer.  If you are a seller of options, and Tesla is known for its large price swings, it makes sense that ATM options are going to have a lot of volatility / time priced in.  
 

When the option is far away from the money the more it behaves like owning the underlying stocks and that is why there is a lot less volatility / time etc costs baked in.  
 

Tesla looks to be priced like many other options are, it would be difficult to make money on ATM except through enormous swings.  

 

I’d say that’s fairly efficient.

 

Sometimes the options markets are really REALLY out of whack though.  I’m thinking oil etfs options were priced so low in 2020 it was laughable.

 

So yeh, that price structure on Tesla seems pretty normal.

[backtothebeach]

2 hours ago, Libs said:

What am I missing? Aren't the $175 puts a much better deal?

 

That's kind of in my wheelhouse. There is no objectively or statistically better deal, otherwise it would be arbitraged away in a liquid option chain like TSLA's, especially right before earnings.

 

One can be subjectively better than the other, though, depending on your expectation of TSLA's stock price and your risk tolerance.

 

Let's say you decide to risk (gamble) $4000 on the expectation that TSLA will fall after next week's earnings. You could buy 2 contracts of the 175 put, or 5 contracts of the 157.50 put. Below are P/L graphs of both positions, at expiration April 26, and on April 24, at the open after earnings (with unchanged IV, which may only be realistic for the first minutes of April 24, probably IV will drop and the options worth a bit less than modeled).

 

You can see that if TSLA either surges or drops a lot, the 157.50 put is superior (max loss is capped at $4000, but max profit is much higher due to more contracts). However you have to be right about a large downmove.

 

The 175 put is "safer" between 150 and 175, and has, as you noted, a higher breakeven - at the cost of each dollar invested not making as much should TSLA drop like a rock to $120.

 

 

 

 

[Gregmal]

It really just depends on what you’re trying to do.

[Libs]

18 minutes ago, backtothebeach said:

 

That's kind of in my wheelhouse. There is no objectively or statistically better deal, otherwise it would be arbitraged away in a liquid option chain like TSLA's, especially right before earnings.

 

One can be subjectively better than the other, though, depending on your expectation of TSLA's stock price and your risk tolerance.

 

Let's say you decide to risk (gamble) $4000 on the expectation that TSLA will fall after next week's earnings. You could buy 2 contracts of the 175 put, or 5 contracts of the 157.50 put. Below are P/L graphs of both positions, at expiration April 26, and on April 24, at the open after earnings (with unchanged IV, which may only be realistic for the first minutes of April 24, probably IV will drop and the options worth a bit less than modeled).

 

You can see that if TSLA either surges or drops a lot, the 157.50 put is superior (max loss is capped at $4000, but max profit is much higher due to more contracts). However you have to be right about a large downmove.

 

The 175 put is "safer" between 150 and 175, and has, as you noted, a higher breakeven - at the cost of each dollar invested not making as much should TSLA drop like a rock to $120.

 

 

 

 

Very helpful, thank you.

[Gregmal]

Why go a week out? 
 

It’s funny you mentioned this because I got bored and saw a trade setup a couple weeks ago and just closed out pretty much this trade. 
 

TSLA at 175 looked good for a hedge. I didn’t want near dated stuff because I’d have to time it perfectly. I didn’t want to go too deep in the money because it’s a volatile stock and can quickly go against you…so less capital exposed was my goal. I settled on Sept $150 puts for $10.50 figuring the time value would buy me a few months to be right. But a quick move to about $150 would bet me 50-70%. Closed em out this morning for $16.5-17. 
 

So…what is your wager?

 

Tesla gonna tank, fast. A timing call? 
 

Hedge you don’t care about not working out?

 

Fundamental short…IE you need time for it to play out and just roll options? 
 

Most crucial thing with this stuff is how you structure it.

 

Also keep in mind, VIX 20 vs VIX 14 matters too. 

[Gregmal]

Conversely, Ill give you another...I earlier also wanted to hedge and the IWM has been money there the past few years. I wanted duration and there is plenty on the chain. But OTM and duration are tough. So I bought $220 Dec 2025 puts. Figured if we rip its ITM enough where I can take another stab while its still got some time to work out...IE 20% move from $205 Would still mean I can save the trade or size it up with a decent probability of it coming back in. So I could double down. Versus if I went for say $150 puts...its a hero trade kinda and a move to $250 more or less crushes the realistic odds I can ever salvage that strike.

 

So in this case I like things where I can have the market be flat and not lose much, go down and make money, or go against me and trade it again. 

[Libs]

With TSLA the growth story is completely broken. No new models, EV'S slumping, layoffs, and all this for 60-70X earnings. The downside is huge and Elon's got nothing that will turn things around for at least 5 years, and that's IF robotaxi and FSD gain traction, which I highly doubt.

 

So I have a fair amount of TSLS, which is great because I can use my IRA to short it. I'll hold TSLS for as long as it takes to deflate this $500B bubble. That's the long-term play and i can weather the volatility in TSLS.

 

The options are short-term gambling, with earnings on 4/23, and expiry 4/26. Smaller in size. My bet is that this recent decline still hasn't priced in the earnings miss that is coming. Also early estimates on Q2 deliveries are really bad - down 10% Y/Y again. 

Edited April 17 by Libs

[lnofeisone]

If this is your hypothesis, I'd go with a vertical bear spread. 140/138, with an expiration of next week, is trading at 0.50. So, if you are right, you get a 4:1 payout, and TSLA only needs to go down to $138. If you bought the 157 ATM Put @8, TSLA would need to go down to 125 to have a similar payout. 

[Libs]

4 hours ago, lnofeisone said:

If this is your hypothesis, I'd go with a vertical bear spread. 140/138, with an expiration of next week, is trading at 0.50. So, if you are right, you get a 4:1 payout, and TSLA only needs to go down to $138. If you bought the 157 ATM Put @8, TSLA would need to go down to 125 to have a similar payout. 

 

I don't see a quote for the 138's , just 135's ($2.00) and 140's ($3.15). So that one (140/135) costs $1.15, and at $135 you make $5 or 4.7:1. Do I have that right?

 

What about the 150/145. Cost $2.25. Stock only has to drop to 145 and you make over 2:1. Not bad. You might be on to something. Thanks.

[lnofeisone]

On 4/18/2024 at 5:46 PM, Libs said:

 

I don't see a quote for the 138's , just 135's ($2.00) and 140's ($3.15). So that one (140/135) costs $1.15, and at $135 you make $5 or 4.7:1. Do I have that right?

 

What about the 150/145. Cost $2.25. Stock only has to drop to 145 and you make over 2:1. Not bad. You might be on to something. Thanks.

what broker do you use? I have ToS and have put in $1 increments in the 108-150 range. 

 

the trade you are proposing is you are risking $1.15 to make $3.85 ($5-$1.15) but you got the idea generally right. 

[Libs]

have put in $1 increments in the 108-150 range. 

 

 

Schwab. I will give that a try, thx.