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Options Theory: Position Sizing a Tesla Trade

April 22, 2021

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Today’s topic comes from a question posed in the Clubhouse. I’ve modified it slightly.

“Does it make sense to sell a one-year, ATM naked put on TSLA if I had a $500k portfolio, and liked the stock?”

Musings of a curious trader

To answer the question we have to touch on both the dynamics of a naked put and proper position sizing.

Naked Puts

Selling naked puts can be a smart way to acquire exposure to a stock, particularly if you’re willing to accumulate shares. Instead of buying shares outright, the short put allows you to get paid for your willingness. Because of this payment, your effective purchase price will be lower than the current market price. As such, many view the short put as a way to acquire stock at a discount. If you want a more in-depth video on naked puts, take a look at the video on short puts in our Tackle Trading Playbook.

I’m always a fan of selling puts. The question ultimately comes down to which month or strike makes the most sense. Additionally, it’s imperative you sell the proper number of contracts given your risk rules. More on that in a minute.

Strike Selection

When it comes to strike prices, you have a choice.

Sell ATM puts: Higher profit potential, but lower odds of success. This is more aggressive.

Sell OTM puts: Lower profit potential, but higher odds of success. This is more conservative.

With TSLA at $730, we would sell the $730 put, if we were using ATM options.

With TSLA at $730, we would sell a put with a strike less than $730 (i.e., $700, $650, $600, etc.)

If you want to take the more aggressive route in exchange for the higher payout, then, yes, selling ATM puts is okay. Keep in mind, even though I’m saying it’s more aggressive, I’m talking in comparison to an OTM put. Shorting ATM puts is still more conservative than buying 100 shares of stock outright.

Month Selection

The question was based on using a one-year LEAPS put option. But you don’t have to use long-term options. There’s a trade-off between month selections. For instance, with TSLA at $730, we could sell the March 2022 naked put for approximately $187 per share ($18,700 total). It has 330 days to expiration or about one year. Alternatively, we could sell the May 2021, 30-day $730 put for around $55 per share ($5,500 total).

Let’s compare the two:

One-year naked put: Capture more premium up front ($187) which creates a wider expiration profit range. This trade will rack up losses slower due to the lower gamma risk. The downside is you have a lower rate of time decay, so the profits don’t come as swift.

One-month naked put: Capture less premium up front ($55) which creates a smaller expiration profit range. This trade will rack up losses quicker due to the higher gamma risk. The upside is you have a higher rate of time decay, so the profits arrive faster.

It’s also worth noting that you could sell another ten or eleven naked puts between now and March 2022, which would ultimately create far more potential cash flow than selling a single one-year put today.

Both approaches are legitimate. Selling the one-year $730 put for $187 places your breakeven and cost basis (if assigned) at $543. That translates into a max risk of $54,300 for each put sold.

Position Sizing

Now that we know the risk involved with selling the put we can have a more intelligent conversation about position sizing. The question assumes we have a $500k account. Is selling one naked put on TSLA too large of a position? The answer depends on how much of your portfolio you’re willing to have in a single position.

Based on the numbers above, you’ll have $54,300 of exposure or roughly 10.9% of your entire account in Tesla.

Obviously, opinions vary on the maximum amount you should place in each position. The higher the percentage, the larger the risk. On a personal level, I don’t like a single stock position to be anymore than maybe 5% to 10% of my portfolio. I’ll go above 10% for ETFs, though.

I’d also consider the nature of the company. We’re not exactly talking about Pepsi or Walmart here. Tesla is a volatile growth stock. I’d be more comfortable with a larger position in a stable stock than I would in something like Tesla.

But that’s just me.

If you had a $100k portfolio and asked about a naked put in TSLA that places over half your portfolio, then I’d dismiss it out of hand. But given we’re at only 10%, it’s not crazy. You could also cut the risk by doing some type of wide bull put. Maybe you sell the $730 strike while buying the $400 strike. That would cut your exposure to less than $30k.

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