Are Mysterious Call Option Purchases Forcing Tesla Stock Higher?

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by Tyler Durden
Wednesday, May 13, 2020 - 02:05 PM

One topic that is occasionally brought up by Tesla skeptics, but rarely examined in depth, has been a litany of out of the money call buying in the name that appears to be occurring, relatively aggressively, on a weekly basis.

While the buying could be attributed to normal market forces, a new article by Dan Stringer looks into the specifics of one such trade that took place last week, where it appeared that over $2.5 million was deployed in a very short term, very out of the money options buy.

In his piece, he looks at the accumulation of Tesla $850 weekly call options, expiring May 8, 2020, which occurred on both May 7 and May 8 (the date of expiration). With the equity trading around $770 on May 7, more than 35,800 $850 strike calls were bought. Then, on May 8, 12,600 more of these calls went off. 

Between these two days, 48,400 call option contracts were entered into for a strike price of $850 within a day of expiration. For context, Tesla shares were trading at around $770 per share on May 7, more than $80 out-of-the-money for these options. Rational expectations would assume that something fairly material would need occur for these to pay out. These were trading at roughly $0.50 per share on the Thursday and traded up to $0.60 per share early on Friday, which would make the total cost of this position $1.79 million for the first 35,800, and a further $756k for the next 12,600 on Friday morning, bringing the total cost of the position to $2.55 million.

(Charts by @EVDefender)

As the piece notes, this is a substantial bet for a "very unlikely" event to occur - namely, Tesla would have to rise by almost 10% over the course of just one day for the options to be in the money.

"The notional value of this trade becomes even more as it represents $3.7 billion worth of Tesla stock at the trading price of $770, where the stock was trading at the close of Thursday, May 7, 2020," the piece says.

(Charts by @EVDefender)

The author then lays out that OCC rules dictate that the clearing house must have a certain percentage of this stock on hand to deal with the calls should they move into the money. He estimates a 20% ratio:

The broker-dealers need to have some margin level (per Rule 601 of the OCC rules); this can vary by broker-dealer and is subject to calculations with these rules. I have heard a typical ratio is roughly 20% on hand, so for the purpose of this exercise, I will use that.

From there, he determines that the options buy would trigger a purchase of 716,000 Tesla shares to cover the trade. He also notes the timing of the transaction, pointing out that "broker-dealer margin requirements are sent out by 10:00 am EST, or within the first ½ hour of trading" and arguing that this could cause a spike at the cash open.

This would create a potential spike in buying at the open, causing shares to spike. The following 12,800 options would then require a further 256,000 shares to be purchased using the same margin requirement methodology.

And sure enough, Tesla spiked first thing Friday morning, Stringer shows:



Finally, he concludes that while the options trade was still a loser, its cost could be offset by a purchase in Tesla shares. A long position of 63,750 shares would have offset the cost of the options trade, since Tesla finished up about $40 on Friday, the author notes.

The author concludes by stating that the options buy could be a "relatively inexpensive" way to generate some forced buying in Tesla.

For a large-cap company like Tesla with the volume of shares that have been trading over the last several months, this option position would be a relatively in expensive cost to generate some forced buying, at a cost of just 5% of the open position.

Recall, the topic of strange call buying was also brought up in a podcast with well known Tesla skeptic, @TeslaCharts, last week. Though the buys were discussed, neither the host nor the guest could speculate as to why these buys might be taking place. Thanks to Dan Stringer's article, they may be on their way to an answer.