An aggressive call options strategy works well when there are spikes in the underlying stock.
We can illustrate the power of call options based on the two spikes in Tesla stock in 2020.
Because of the COVID-19 pandemic, all companies took a major hit in March 2020. TSLA reached its lowest point in 2020 on March 18, with a price of $72.24 (split-adjusted), before finishing the year at $705.67, rising nearly 9x after its low (or 877% to be exact).
Two events in 2020 caused two major spikes in Tesla’s stock price:
Spike #1: Tesla’s 5-to-1 stock split
On August 11, 2020, TSLA was at $274.88 (split-adjusted), when Tesla announced a 5-to-1 stock split to take place on August 31.
In the next three weeks leading up to the split, the stock rose to an all-time high of $498.32 the day of the stock split: an 81% spike in three weeks.
Employing a Call Options Strategy
However -- anyone who immediately bought TSLA call options on August 11 would have made far more than an 81% profit.
Investors buy call options when they think the underlying stock will rise. However, a massive profit can be made on call options if the underlying stock not just slowly rises, but spikes.
When we buy call options, we have to make two decisions based on our strategy: (1) the strike price, or the price we think Tesla might rise to; and (2) the expiration date of the options contract, based largely on when we think the spike will occur.
Regarding the expiration date, if we anticipated the rise in Tesla stock price to peak around the stock split date (August 31), we should still choose an expiration date about two months later in November, in order to avoid time decay and its price reducing effects on options.
Regarding the strike price, TSLA was at $274.88 on August 11, so we could buy at three different prices: (1) ~50% price increase to $410, (2) ~75% price increase to $480, and (3) ~100% price increase to $550. These are all aggressive, out-of-the-money (OTM) call options.
To summarize: In August 2020, an aggressive call options strategy would have bought call options expiring in three months (Nov 2020), and would have chosen three different strike prices that would have represented a roughly 50%, 75%, and 100% increase in Tesla’s stock price.
The Outcome of Call Options vs. TSLA stock
These are the price of these options compared with the price of Tesla stock, and the percentage gain of each:
As you can see, the difference in percentage gain is massive.:
- The call 410 11/20 outperformed 11.8x TSLA stock itself
- The call 480 11/20 outperformed 15.x TSLA stock itself
- The call 550 11/20 outperformed 17.4x TSLA stock itself
Based on historical options data, we can chart the percentage gain over time:
Summary: In August 2020, despite a strong 81% gain, Tesla stock vastly underperformed the Tesla call options chosen via an aggressive out-of-the-money (OTM) options strategy.
Spike #2: Tesla’s S&P 500 Inclusion
Despite four consecutive quarters of profit, Tesla was passed over for inclusion in the S&P 500 in September 2020. However, after its fifth straight quarter of profits, Tesla was chosen for inclusion in the S&P 500.
The announcement was made on November 16 (when TSLA was at $408.09), and the actual inclusion happened on December 21. TSLA reached a high of $694 the trading day before inclusion, dipped a bit, then finished the year at an all-time high of $705.67: a 73% spike in six weeks.
Employing a Call Options Strategy
Anyone who immediately bought TSLA call options on November 16 expiring near or past the stock split date (December 21) would have made far more than a 73% profit.
Regarding the expiration date, if we anticipated the rise in Tesla stock price to peak around the S&P 500 inclusion date (December 21), we should still choose an expiration date about two months later in February 2021, in order to avoid time decay and its price reducing effects on options.
Regarding the strike price, TSLA was at $408.09 on November 16, so we could buy at three different prices: (a) ~50% price increase to $610, (b) ~75% price increase to $700, and (c) ~100% price increase to $800. These are all aggressive, out-of-the-money (OTM) call options.
To summarize: In November 2020, an aggressive call options strategy would have bought call options expiring in three months (Feb 2021), and would have chosen three different strike prices that would have represented a roughly 50%, 75%, and 100% increase in Tesla’s stock price.
The Outcome of Call Options vs. TSLA stock
These are the costs of the options compared with the cost of Tesla stock, and the percentage increase of each:
As you can see, the difference in percentage increase is massive:
- The call 610 2/21 outperformed 15.3x TSLA stock itself
- The call 700 2/21 outperformed 16.1x TSLA stock itself
- The call 800 2/21 outperformed 13.6x TSLA stock itself
Based on historical options data, we can chart the percentage increase over time:
Takeaways:
(1) Call Options Have Risk, But It's Limited
Call options are riskier than buying the underlying stock. Yet, even in the worst case scenario, the maximum loss is the cost of the options (i.e., the premium paid). Looking back to the examples, if TSLA failed to spike, only mildly rose, or even fell -- the absolute worst-case scenario would have been losing the premiums paid:
(2) Call Options Have High Reward Potential
However, call options can vastly outperform the underlying stock when there are spikes. We illustrated that in 2020, an aggressive call options strategy would have outperformed Tesla stock itself by anywhere from 12x to 17x better. The following are best-case scenarios:
Tesla’s stock could spike again within the next year or less, due to an imminent release of its full-self driving technology. These potential upcoming spikes in Tesla could be an opportune time to look into Tesla call options for out-sized gains.
