Tesla Heading for a Breakdown

Posted On December 3, 2015 9:45 am

The electric maker has a hard road toward meeting its lofty expectations. A bearish option play could drive big profits.

Electric car maker Tesla (TSLA) has also been a stellar stock, gaining over 320% over the past few years. But this one is built strictly on promise as the company is still far removed from turning a profit.

A lofty valuation is fine for companies that have high growth potential but unlike some tech/internet businesses which have blue sky opportunities, whether it be Facebook or Amazon and even Netflix which have an almost unlimited addressable market and can grow beyond the initial business.  The size of the auto industry is finite and known.  Even if Tesla can managed to get to 15%  which would be a pipe dream — I think they are ambitious at trying to get to 3% – the stock would still be overpriced.

Tesla CEO Elon Musk inspires a cult like following but just don’t think he will achieve his vision. The company burned through $359 million in cash last quarter in a bull market for luxury vehicles.   Musk plans to spend a staggering $700 billion on capex over the next 10 years and has been forced to issuing a secondary stock offering and has been reliant on the largess government subsidies and tax breaks.

Missing the Mark

It future rests on producing a mass market sub $35,000 vehicle with a target of 500,000 cars per year by 2020. But it won’t even begin producing the Model 3 until late 2017.   By that point competitors such as BMW are expected to have a full line of fully electric vehicles. Also, Industry experts claim that the gigafactory being built in Nevada won’t measurable reduce the per unit cost of batteries meaning the challenge of a mass market car harder than just production issues.

The other big obstacle and cash burn is the need for Tesla to build out the infrastructure for its supercharging stations. Mr. Musk stands at a crossroads of three industries that have always been rich in swashbucklers and hype: energy, cars and technology. I think too many things have to go right for Tesla to meet its promise and become profitable company.

As of now the company has failed to meet even its own modest production goals over the past few quarters and recently acknowledged it is unlikely to hit the 55,000 mark for 2015. Sources say the company is losing more than $4,000 on every Model S electric sedan it sells and has turned towards more incentive to sell the cars. At best the Model S will remain a niche market that appeals to a few people that want to accelerate at “ludicrous speed” or ungainly gull wing doors. Such gimmicks won’t build a sustainable model.

In fact, the initial glowing reviews have lost their shine. Consumer reports, which initially gave it Spinal tap like “110%” rating has now downgraded it based on actual owner survey reports which complain of basic malfunctions with the touchpad doors to electronic breakdowns. Basically, the one off performance on attest track does not hold up over time under real driving conditions.

Waiting in the Wings

Right now the valuation the main thing ludicrous about the company, it has a market capitalization of $30 billion which is more than half of BMW which produces 35 times as many cars. And BMW actually makes money on its cars. So does Ferrari (RACE) which was recently spun off and sports a market cap of just $9 billion or less the a fourth of Tesla.

And just as BMW (and Audi) will attack the luxury and SUV electric market so will the major such as General Motors (GM), Ford (F)and Toyota ™ jump into the middle $25,000-$35,000 as they can ramp up production of the Volt, Focus and Leaf respectively once they deem the demand warrants.

The industry stance seems to be, let Tesla build test the waters, work out the bugs, incur the costs building the infrastructure for battery production and fueling stations and then we will jump in and build the mass market electric vehicles at a profit.

Chart Back to Sell Zone

Investors initially sold off shares following the 2nd quarter earnings report in late August when production numbers were lowered and losses increased. Then the stock jumped following disappointing third quarter report moving from the $200 to $240 level.

TSLA  chart 12.2.15

As both consumers and the investment community become less enchanted with Tesla vision I think the stock will be punished and drop back down to the $180 level as it misses milestones over the next few months.

The Trade:

The next main catalysts for the company will be end of year sales totals and then 2016 first quarter earnings slated for late February. I want to capture both events in which misses should send shares back toward the 52-week low near the $180 level. I’m using a basic put spread in the March expiration. Specifically;

-Buy March $230 Puts

-Sell March $180 Puts

For a $14.50 Net Debit

Here is the risk graph for this position.

TSLA risk 12.3.15

My expectation is that shares of Tesla could sink back below $180 by the March expiration which make the spread worth $50 or a 244% gain over the four month holding period.

This is admittedly a bold and contrarian prediction. But sometimes when you dream big you end up failing big. Or in the case of this position, we’re dreaming of a big failure to turn into big profits.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.