Contracts in Tesla are currently sitting at an implied volatility of 35.97, which indicates that Wall Street saw risk in owning shares in the company lower only 2% of the time since its IPO in 2010. A brief look at a chart in $TSLA shows pretty drastic price action this year, action that might suggest that options in Tesla may be underpriced.
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| Red, white, and blue moving averages. The three parallel blue lines outline the "trend" in Tesla. |
One thing we do know about volatility is that it is mean reverting. Mean reversion is a phenomena that occurs quite frequently in nature. When the behavior of a system is displaced from equilibrium, it will tend to revert back to the state prior to displacement. For instance, a vibrating guitar string will not ring forever: after it is plucked, it will return to a state of equilibrium (which in the case of the string is "at rest").
This analogy applies analogously to volatility in markets. States of frantic selling or buying are only momentary; markets will eventually want to revert back to a state of equilibrium, or in other words, revert back to its mean. In terms of movements in stock prices, mean reversion can be seen by drawing a "trend line". I estimated the trend line for price action in Tesla with the three parallel blue lines up above. As you can see, each time price diverged from the central line, it had the tendency to move quite drastically above and below it, only to return to it.
One of my favorite assets, the $VIX, which is literally an index of volatility itself, demonstrates that it is indeed a mean reverting phenomena.
I applied a linear regression to the index. As you can see, market volatility tends to return to the central trend line of mean reversion. Irrationality transforms to price discovery which transforms to price stability as global markets learn from trial and error.
As of today, August 19th, the markets have returned to the central trend that Tesla has been wanting to revert to. Wall Street, at this point and time and with all known information regarding the company, generally agrees on a price around $255 a share.
I must re-emphasis the phrase "all known information". Tesla traded near this mark around Feb/March of this year, but at the time, there was very little information regarding its market operations in China or its soon-to-be gigafactory. A disappointing earnings report Q1 2014 caused a frantic sell-off in the stock to about $180 before markets got their metaphorical shit together and realized a bargain was at their hands. The price reverted back to its trend line in July.
Fast-forward to today and markets agree that $255 is an acceptable price now knowing of their intents in China, expansions in the US infrastructure, and production capacity. All these variables are currently "priced-in" to the stock.
However, as speculators, option traders now have one of the biggest opportunities to profit off of price movement in the company. From a volatility perspective, options in the company have only traded cheaper 2% of the time.
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| Notice that the implied volatility of share in Tesla also has a mean it reverts to (~50% IV) |
A quick look at the implied volatility of shares in Tesla shows that options are "cheaper" than they have been in quite a while. This is for a company that many people believe can be the "next big thing", and not to mention, is very young. Unlike Apple, which has been publicly traded for decades with multiple splits, the amount of available shares in the company are relatively few. The sale of a single share in the company has the ability to move the price more drastically than shares in any NYSE component.
That being said, shares in Tesla won't implode/explode today or tomorrow, or even by the end of this month necessarily. What the take home point is that at some point, we know that volatility will increase in the company. As you may or may not know, option traders have the ability to construct a delta neutral position that exposes one only to volatility in movement and not directionality of price. But for those of you so inclined, you can "cheaply" speculate on the future price of Tesla.
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