The Perils of Shorting: A Real Life Example

Duke of Marmalade said:
A PUT Option is in effect insurance. With huge volatility something like Tesla is likely to carry a very high insurance premium. That of itself is okay if you could be sure that the premium was "fair". In a direct Long/Short position there is complete transparency on the bid/offer spread. Unless the Option is being traded in a two way market there would be no transparency on the spread. My guess is that if there are writers of Options on Tesla they will have a whopping mark-up or spread.
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Listed options - you get the bid/offer and price action. Can also use LEAPS (long dated exchange traded options) if you want to extend out the timeframe
 
EmmDee said:
Listed options - you get the bid/offer and price action. Can also use LEAPS (long dated exchange traded options) if you want to extend out the timeframe
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If listed on a two way market, I agree that there would be transparency on the bid offer spread. I am not sure if Tesla options are so listed.
 
Thanks @EmmDee you beat me to it

@Duke of Marmalade, it’s a very large offering with a multitude of strikes and expiries particularly in the short end. Naturally they begin to space out at the back end of the maturity period.

I agree the implied volatility is huge with Tesla which factors dramatically into the option prices but spreads on the bid/offer are relatively tight.

It’s fair to say that put options need not be viewed as only an insurance contract but also as a way of taking an active short position in a synthetic manner.I’ve seen some pretty creative amalgamations of various option structures else where that create a nice bit of exposure without a huge outlay.

Perhaps the retail option market is not as advanced in Ireland.
 
Risk Reversal said:
I agree the implied volatility is huge with Tesla which factors dramatically into the option prices but spreads on the bid/offer are relatively tight.
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If volatility premium is a large chunk of the option pricing, it is possible to somewhat alleviate that element using spreads... For example buying 1,200 puts and selling 800 puts (or similar with expiry date spreads). While you pay a higher premium for the long put, you also receive a higher premium on the short leg.

Worth playing around with if you're looking for a more affordable short position
 
EmmDee said:
If volatility premium is a large chunk of the option pricing, it is possible to somewhat alleviate that element using spreads... For example buying 1,200 puts and selling 800 puts (or similar with expiry date spreads). While you pay a higher premium for the long put, you also receive a higher premium on the short leg.

Worth playing around with if you're looking for a more affordable short position
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EmmDee can you explain that example a bit better for a poor Duke. I can see that with such a vast array of possibilities tailoring the best combination to suit one’s situation is possible.
 
Duke of Marmalade said:
EmmDee can you explain that example a bit better for a poor Duke. I can see that with such a vast array of po - ssibilities tailoring the best combination to suit one’s situation is possible.
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Sure - had a look at closing prices last night. I've picked strike prices which had active trading yesterday and therefore an active bid / offer. So a bit arbitrary but hopefully it's clear.

Looking at September 17th 2021 expiry - a year out. Assuming you wanted a short position which will move into the money if the price moves down between now and then - but not needing the price to get to the strike price by September.

Sep21 $1,015 put yesterday was $179.50 / $186.70. So essentially you would be paying $186.70 per share for the put option at $1,015 (these traded options are for 10 shares but the price is per share - so one option would cost $1,867 for 10 shares exposure). So even though the option is out of the money it's not cheap - because as mentioned there is a lot of volatility pushing up the price.

Sep21 $570 put was $45.70 / $49. You could sell these options (at the same time as buying the above) receiving $457 in premium. So the net cost on this spread would be $1,410. So reducing total cost to open a position.

The offset for the reduced cost is that you are capping your potential return - it is absolutely capped at $$445 per share. The gain on the position will also be a % of the absolute change in underlying stock price - true of all out of the money options.
 
EmmDee said:
Sure - had a look at closing prices last night. I've picked strike prices which had active trading yesterday and therefore an active bid / offer. So a bit arbitrary but hopefully it's clear.

Looking at September 17th 2021 expiry - a year out. Assuming you wanted a short position which will move into the money if the price moves down between now and then - but not needing the price to get to the strike price by September.

Sep21 $1,015 put yesterday was $179.50 / $186.70. So essentially you would be paying $186.70 per share for the put option at $1,015 (these traded options are for 10 shares but the price is per share - so one option would cost $1,867 for 10 shares exposure). So even though the option is out of the money it's not cheap - because as mentioned there is a lot of volatility pushing up the price.

Sep21 $570 put was $45.70 / $49. You could sell these options (at the same time as buying the above) receiving $457 in premium. So the net cost on this spread would be $1,410. So reducing total cost to open a position.

The offset for the reduced cost is that you are capping your potential return - it is absolutely capped at $$445 per share. The gain on the position will also be a % of the absolute change in underlying stock price - true of all out of the money options.
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Understand. It was the double use of the word "higher" in the original post that perplexed me. I think it meant "higher because of the implied volatility". I won't be dabbling myself but I can see that with such a vast array of Options it should be possible to tailor a combination which better reflects one's personal risk/reward profile and judgement of the possible outcomes than the crude direct short.

Summarizing your example. The package costs $141 per share. If in Sept 2021 the price is above $1,015 you get nothing and therefore lose the full $141. If it is below $570 you receive $445 and therefore gain $304 and between these figures interpolate with break-even at $874. It doesn't look a great proposition to me but then again I could sell the package (subject to bid offer spread)
 
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Brendan Burgess said:
Hi Coyote

It's the paradox of shorting.

If you short something at $100, and it rises to $150, then it's an even better short if nothing has happened in the meantime to justify the increase.

But from a portfolio point of view, your losses are probably too great and you can't risk any more.

Brendan
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Brendan, I think PUT options resolve this paradox. The problem with a short is that if it starts going wrong you get more and more exposed. Thus in your example you start off risking $1 for a 1% rise in price but that becomes a risk of $1.50%. Long positions do not suffer from this syndrome.
But neither do PUT options. As PUT options move out of the money they come less and less risky. Basically that is because they have a limited risk in the first place.
 
Duke of Marmalade said:
Understand. It was the double use of the word "higher" in the original post that perplexed me. I think it meant "higher because of the implied volatility". I won't be dabbling myself but I can see that with such a vast array of Options it should be possible to tailor a combination which better reflects one's personal risk/reward profile and judgement of the possible outcomes than the crude direct short.

Summarizing your example. The package costs $141 per share. If in Sept 2021 the price is above $1,015 you get nothing and therefore lose the full $141. If it is below $570 you receive $445 and therefore gain $304 and between these figures interpolate with break-even at $874. It doesn't look a great proposition to me but then again I could sell the package (subject to bid offer spread)
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Great example @EmmDee. I understand though that an option contracts are based off 100 shares rather 10 shares as you outlined.

With Tesla therefore, even significantly out of the money options such as the $1,015 strike contract need a considerable outlay before you recoup some of this premium via the $570 strike

I always find that pay off graphs are super for visualising your potential returns at various points but totally appreciate these are hard to display here.

Tesla single options or combinations do require deep pockets but it is worth considering these strategies for other modest price shares. In these cases the above example can work well where slightly out of the money options trade for circa €2-3 and a short can be achieved for a relatively modest outlay such as €150 for a position in a 100 shares.
 
Risk Reversal said:
Great example @EmmDee. I understand though that an option contracts are based off 100 shares rather 10 shares as you outlined.
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Yeah - you're right. Even as I was writing that I had a niggling feeling I had something wrong. Assumed I had used the wrong side of the bid / offers

Thanks
 
EmmDee said:
https://www.nasdaq.com/market-activity/stocks/tsla/option-chain
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This is a truly fascinating site. I see that the Implied Volatility for At The Money Sept 21 Tesla options is c. 70% whilst that for Apple is 35%. In layman's terms that means the market thinks the chances of Tesla being less than 50% of its current value in Sept 21 is 1 in 3 whilst for Apple it is 1 in 20. Obviously this means options on Tesla are extremely expensive.
 
jhegarty said:
not a good month for shorts.
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Hi J

Agree fully.

However, if a paper transaction can result in a 13% price increase, it shows you the mentality of the people who are buying Tesla at these prices.

So not a good month for people who have already shorted, but a great time for anyone who is thinking of shorting it.

Brendan
 
The price is complete insanity , but I don't see anything ahead that will end the insanity.

Once the S&P inclusion comes in there will be another big jump.

I got back in after the announcement and am already up another 11% in just over 24 hours. It's madness , but it's madness what can you do.
 
jhegarty said:
I got back in after the announcement and am already up another 11% in just over 24 hours. It's madness , but it's madness what can you do.
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I am reminded of a saying attributed to Warren Buffett:
"In the short-run, the market is a voting machine; in the long-run it's a weighing machine"
Even Tesla's biggest fans must agree that it's perverse that a decision to offer investors five times as many shares at one-fifth their previous value (five times one-fifth = 1) adds $50 billion to the company's value. That is what I estimate has been the increase in the company's market value between close of business on Wednesday, when the split was announced, and today. Nothing else of note happened in the meantime that might affect Tesla's share price.
The voting machine is working overtime just now. The number of Tesla accounts on the Robinhood investing website jumped from 180,000 to 550,000 since March this year. Fair dues to @jhegarty for taking advantage of it.
My money is on the weighing machine coming out on top in the long-run. I'm prepared to wait (while limiting my risks this time, as noted in a recent post).
 
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