A Good Week to be Short

by JDH on July 28, 2018

I’m not a short seller.  I’m an optimist, and being a short seller implies that you are a pessimist.  It’s bad karma.  I prefer to take an optimistic approach.

Also, the most you can make shorting a stock, un-leveraged, is 100%.  If you short a stock at $100 and it goes to zero, you made 100% profit (ignoring borrowing costs and fees, which are not insignificant).

Going long, you can make an infinite amount of money.  A stock purchased for $10 could go to $1,000.  The upside is unlimited, which is another reason that going long is better than going short.

Even worse, shorting a stock can only make you 100%, but your losses are theoretically infinite.  If I short a stock at $100 and it goes to $1,000, I just lost ten times my money.  To summarize the risk/reward ratio: selling short, you can lose an infinite amount of money, but only make 100%.  Those are not good odds.

So why am I rambling on about something I don’t do? Because sometimes a detailed analysis of a stock shows that it is more likely to go down than up.

Wouldn’t it have been great if you were short Facebook this week?  It closed at $218 on Wednesday, and touched $173 on Friday.  That’s an over 20% drop on a stock with a market capitalization of over $500 billion.  The short sellers did fine on that one.

You know where I’m going with this, and it has nothing to do with Facebook (or Twitter, another social media stock that got hammered on Friday).

I’m talking about Tesla Inc., my favorite short selling candidate.  I explained last week why I am still short on Tesla, so I won’t restate the case again, other than to say that they are bleeding cash, and are nowhere close to earning a profit.

So how do I reconcile the two thoughts: I don’t like the risk/reward ratio of short selling, but I think Tesla is going down?

I don’t short the stock.  I buy puts.

The disadvantage of buying options, either calls or puts, is that they are a wasting asset.  They have an expiry date, so each day they become less valuable.  They are not a long term hold; they are a short term strategy.

The advantage of buying puts (or calls) is leverage, and the most you can lose is 100% of your investment, not an infinite amount.

So, I am currently playing with the TSLA puts with a $300 strike price, expiring on August 31, 2018.  That’s only five weeks away, so they are eroding in value very fast.  My hope, of course, is that Tesla erodes in value much quicker, as it did this week.  After trading as high as $310 on Wednesday, it closed the week at $297.19.

My strategy is simple:

First, don’t play with big money. This is a speculation, a gamble, not an investment.  If I get wiped out, I’ll be disappointed, but I will live to fight another day.

Second, take profits quickly.  If after a day or two the position is up, cash in.

Here’s the big risk: this is a volatile stock.  Tesla releases earnings this week.  It’s possible that by bulging production at the end of June they will be able to report higher than expected revenue, which may make the stock pop.  That would be bad for my puts.

Of course they could “pull a Facebook” and be down 20% in one day.  That would be great for my puts.

The August 31 $300 puts closed on Friday at $22.53.  If Tesla crashes 20% on Monday they would be worth around $60 (give or take ten or twenty dollars either way), so that could be a 300% gain.  That would be fine.

So, since the gold stocks are still slumbering, and the cannabis stocks won’t start rocking again until we approach legalization day on October 17, we’ll have some fun with Tesla for the next week or two.

Stay tuned.