Why Tesla At $1,900 Is 'Free Money'

Simon Constable. Forbes 25 January 2021

Last week I got a call from a friend who told me that Tesla stock could be my way to riches.

He noted that the stock was recently trading at $883 a share but that some people were buying call options at [an exercise price of ] around $1,000 more a share. That's [an exercise price of] approximately $1,900 if you were wondering.

 

"[Selling] Tesla at [an exercise price of] $1,900 is free money," he said.

 

How's that? I asked.

 

My friend, who doesn't want to be named, noted that if Tesla stock made it to $1,900 then the company would be worth $1.8 trillion, according to my calculations based on data from Yahoo.

"That's crazy," he said. The point was that such a valuation was insane even though there are other tech companies that have market caps over a trillion dollars. (They include Amazon and Apple , for instance.)

 

He has a point. How could such a valuation could be justified? 

 

It could not, my friend states.

 

One way to look at that is to compare it to the size of California's economy, $3.1 trillion and home to some vast industries. To say that in one year's time Tesla could be worth more than half of what would be the fifth largest economy in the world makes little sense.

That's where the $1,900 and the free money comes into play.

He found that call options set to expire a little over a year from now and that had a strike price around $1,900 were selling for tidy sums. Call options pay out if the share price exceeds the strike price at the expiration date. [If the share price doesn't exceed the strike price at expiration date, then the option seller makes a profit.]

 

Required - With reference to the article "Why Tesla At $1,900 Is 'Free Money'", answer the following:

a) Do you agree that selling Tesla call options with an exercise price of $1,900 is "free money"? Explain your answer. 

b) Is a $1.8 trillion dollar valuation for Tesla inconsistent with an efficient market? Using a valuation model discussed in class, how can you justify such a valuation?