On Wednesday, the Federal Reserve lowered the federal funds rate target range by 25 basis points to 4.25%-4.50%. This marks the third consecutive rate cut following the initiation of an easing cycle in September. After a cumulative hike of 525 basis points from March 2022 to July last year, the Fed has now cut rates by a total of 100 basis points over these three instances.
Since U.S. President Donald Trump secured his second term, Tesla has been riding a wave of positive sentiment, with its stock price surging over 90%. On Tuesday, Tesla closed at an all-time high for the fifth consecutive trading day, gaining 3.64% to finish at $479.86.
However, on Wednesday, Tesla’s stock price dropped over 8% at market open, wiping out $131.5 billion in market value (approximately ¥962.5 billion). By the end of the trading day, Tesla became the most actively traded stock on the U.S. market, closing down 8.28% with a trading volume of $65.998 billion.
For investors looking to short Tesla, the Bear Call Spread strategy might be worth considering.
What Is a Bear Call Spread?
The Bear Call Spread is an options strategy used by traders expecting a stock’s price to decline within a specific timeframe. This strategy is designed to short the underlying asset while limiting risk exposure.
It can be constructed using either call or put options:
Bear Call Spread: Selling and buying call options with different strike prices.
Bear Put Spread: Buying and selling put options with different strike prices.
Bear Call Spread:
Sell a call option with a lower strike price.
Buy a call option with a higher strike price.
Bear Put Spread:
Buy a put option with a higher strike price.
Sell a put option with a lower strike price.
The primary advantage of a bear spread is its ability to limit the risk of shorting. For example, directly shorting a stock can lead to unlimited losses if the stock price rises sharply. In contrast, a Bear Call Spread caps the potential loss. Variations, such as using options with different expiration dates, can further enhance flexibility (e.g., calendar spreads).
Example: Tesla Bear Call Spread
Let’s assume Tesla is trading at around $439 pre-market. If an investor anticipates Tesla’s price will drop to around $300 in the next month, they can establish a Bear Call Spread in two steps:
Sell a Call Option:
Strike Price: $300
Expiration: January 17
Premium Received: $14,515
Buy a Call Option:
Strike Price: $440
Expiration: January 17
Premium Paid: $3,708
Net Premium Received:
$14,515 - $3,708 = $10,807
Profit and Loss Analysis
1. Maximum Profit
Condition: Tesla’s stock price ≤ $300 at expiration.
Amount: Net premium received.
Max Profit = $10,807
2. Maximum Loss
Condition: Tesla’s stock price ≥ $440 at expiration.
Amount: Strike price difference - net premium received.
Strike Price Difference = $440 - $300 = $140
Max Loss = (140 × 100) - $10,807 = $3,193
3. Breakeven Point
Breakeven Price:
Upper Breakeven = $440 - ($10,807 ÷ 100) = $331.93
Key Characteristics
Maximum Profit: $10,807 if Tesla’s price falls below $300.
Maximum Loss: Limited to $3,193 if Tesla’s price rises above $440.
Breakeven Point: Tesla’s price at $331.93 results in neither profit nor loss.
Risk-Reward Analysis
Max Profit: $10,807
Max Loss: $3,193
Risk-Reward Ratio: $10,807 ÷ $3,193 ≈ 3.38
Strategy Insights
Market View: Ideal for scenarios where Tesla’s price is expected to drop moderately (below $300) or remain range-bound (not exceeding $440).
Risk Control: Limited potential loss by buying the $440 call option.
Return Potential: High net premium from selling deep in-the-money options.
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