Tesla makes electric cars and has reported a small profit in each of the last two quarters. If analysts are correct, the company should make $1.85 a share in 2014, and earnings-per-share growth should average about 19 percent a year in the future.
Based on next year's expected earnings, Tesla is trading at a price-earnings ratio of 98. The price of Tesla is unsustainably high and rational investors should expect the stock to fall sharply.
The obvious trade is to short Tesla and profit from its decline. Unfortunately, an irrational market can remain irrational for an extended period of time. Short trades have unlimited risk and there is a safer alternative.
Based on its earnings, Tesla is probably worth about $40 a share. Aggressive investors could buy a put option to benefit from a potential decline. A put expiring in January 2015 with a strike price of $80 would be worth at least $40 per share if Tesla fell to its fair value. Investors could buy that put for about $8 a share. The potential gain is $4,000 (400 percent) and the total risk is $800.
Eventually all bubbles pop and Tesla is a bubble. From a highly technical perspective, the price of Tesla closed more than three standard deviations above average on Sept. 20. This is a level rarely seen in the stock market.
MicroStrategy traded three standard deviations above its average price on March 7, 2000, and the Internet bubble began to implode a month later. The Philadelphia Housing Index topped this level on Jan. 9, 2006, and the housing bubble popped when the S&P Case-Shiller 20-City Home Price Index peaked in April of that year.
We have seen a number of bubbles in the past few years. Studying them allows us to learn when they are about to end. Tesla has most likely reached its peak and aggressive investors should consider benefitting from this bubble.
© 2015 Newsmax Finance. All rights reserved.