By: Steve Smith
Tesla (TSLA) was officially added to the S&P 500 Index (SPY) as of last Friday. Shares surged in the final minutes to $695, a new all-time high as index-based funds were mechanically forced to buy shares. Those gains were quickly given back as shares dropped some 8% in the next two days of actual trading.
This is a signal that TSLA’s will become a less volatile stock as it moves from renegade to a member of the blue-chip SPY index.
Today, the Options360 Service portfolio established an advantageous iron condor position. The addition to SPY will lead to a shift in Tesla’s trading dynamic.
I can’t give the specific details of the position just yet, since it’s exclusively for Options360 members. However, I’ll explain why I think TSLA could be a cash machine — through premium collection — for months to come.
My basic premise for beginning a premium selling program is that TSLA is simple. I anticipate that volatility will decrease as it will now be anchored by the large index funds that need to maintain an accurate allocation, thereby dampening price swings.
When a stock joins the S&P 500, it becomes part of a massive volatility complex, which is a terrifying web of arbitrage and pseudo-arbitrage relationships. TSLA joins the index with a weighting of 1.6% making it a top-ten component of a cap-weighted index.
This means that all manner of dispersion, relative value, and market-making traders begin relying on Tesla’s newfound correlation to the index. This will invariably cause arbitrageurs to buy SPX options/vol and sell TSLA options/vol to “close the spread.”
A decent portion of Tesla’s stock rally has been driven by aggressive buying of call options, creating a feedback loop making it a slave to “vanna“: the relationship between option prices (implied volatility) and delta (stock exposure). Tesla’s one of the few stocks in which calls have become more expensive than puts, and this has been accentuated as short-sellers have been forced to cover.
Now that TSLA has entered the index, these historic call option flows and the hype machine behind them will hit the big red fire truck that is the SPY at 500mph
Implied volatility will be unable to rise. Call options will bleed value. New flows will be absorbed by the near-$4.5 trillion tied to the index.
Secondarily, now that TSLA is now part of the staid S&P Index, aggressive funds and individual investors will need to look for the next shiny, new electric vehicle company, of which there is no shortage, to chase and produce alpha or portfolio outperformance.
Today, the Options360 Service established the first of what I expect to be cash machine trades over the next few months as TSLA settles into its newly established, index-bound stock role.