I have a question jhm - I don't recall if you have tested correlation between Tesla and oil (or the particular instrument you're using) very far back. My question amounts to - for how far back, historically, have you found a strong enough correlation between the two for you to choose to act?
I don't have a strong opinion about Tesla/oil correlation (I can argue a few different sides qualitatively), but it seems like the last few months have been much more a story about strong broad stock market correlation with oil, with Tesla going along for the ride with the broader market.
I suppose the conclusion this leads me to is this that to the degree this is true, then you've got a market hedge.
Also to be clear, this is primarily a question of curiousity. In one of your earlier posts, I believe you talked about the possibility of Tesla and oil getting disconnected, and oil staying flat or dropping, while Tesla continues to rise. I consider that to be a reasonable scenario, in which case you're winning on both sides of your trade. I am also in agreement about the upper bound on the price of oil that is working it's way in.
I am starting to wonder at what point the world has no more storage for oil available and what happens then? There is a velocity and inertia to this stuff as it is pulled up and moved around. Filling up world storage for oil may force a slowdown or shutdown of oil wells simply because there's nowhere to put the stuff
Well, if you start with the monthly file I posted above and compute monthly relative changes for both TSLA and SCO, you can also computer rolling 12 month correlation. This data goes back to June 2010. Virtually every rolling correlation is negative, all but the very first 12 months. It does very a bit over time, so this suggests that an adaptive hedge ratio may be more suitable. Even so this looks like fairly consistent correlation. One little point I would add is that it helps to look at returns over a longer period of time, like several weeks to month or two. Daily price changes are not as strong.
So I feel pretty good about this relationship, especially if the hedge ratio is adaptive.
Now there are lots of reasons why such a correlation might exist. Oil is in fact a major macro economic variable. My view is that oil can drive stock market prices, but I am less inclined to see stock market prices as a driver of oil prices. Oil and gas stocks are about 20% of the stock market. Clearly the price of oil has a causal impact on the valuations of oil related stocks.
So while the stock market and oil are correlated, I have distinct views on what risks I'm interested in hedging against. Clearly, Tesla is a high beta stock with respect to the stock market; however, I am not interested in hedging against that risk, at least not under normal circumstances. The reason is that the market risk is in fact the nondiversifiable risk that creates most of the value of holding stock, any stock. So if I do not wish to hold market risk, I simply should not hold any stock. Oil price risk, however, is a specific macroeconomic risk to certain stocks that I do not wish to have in excess. The basic fact that I can construct a portfolio of TSLA and SCO which is nearly uncorrelated with oil and which yeilds favorable to holding TSLA by itself is suggestive that oil risk may be a diversifiable risk. And such a diversifiable risk is ultimately not rewarded under an efficient market. In the case of Tesla I am in fact will to suspend belief in an efficient market, and this provides an even stronger rationale for hedging the position. So the essential question is whether a hedged Tesla portfolio provides better risk adjusted returns than an unhedged position. If so, the market cannot be expected to reward you for holding unhedged risk.
My longterm view is that Tesla will eventually become uncorrelated with oil price risk. Indeed, as Tesla disrupts oil it may become negatively correlated. But even this will fall to the wayside as oil withdraws from the energy market and fueling vehicles. Oil will be a great source of asphalt and petrochemical long after we cease to use it as a fuel. So the super long view is no oil risk for Tesla. It's really hard to tell how soon oil and Tesla may decouple. I do rather suspect that oil price declines embolden shorts to attack the stock and oil increases can embolden longs to drive up the price. Especially if this is working as a driver of sentiment, I want to hedge this. If there are deeper issues like the value of the US Dollar, general economic demand, global security, and other issues, then it is not a bad hedge to have. For example, the US dollar is quite strong right now, this is in fact a real risk for Tesla. It forces Tesla to raise prices in other currencies and so impedes exports. Why not have a little hedge against currency risk?
My hope is that other folks will explore different sorts of hedges for anything that concerns them and will share their ideas. My own Tesla position has become too large for me not to consider a variety of risk reduction strategies. Many of the folks who actively trade Tesla want to dodge in and out of a long position depending on their read of circumstances. This is not my style. So if ever I become concerned that the oil market might tank and take Tesla with it, I am very glad that I can hedge that risk in lieu of selling off shares or buying puts. I suppose in this light a stock market hedge could be worthwhile too. So staring down a bear market one can short the market in lieu of selling off Tesla shares. So I keep this in mind as we encounter different macroeconomic headwinds. Short term hedges can have tactical uses. In the case of oil price risk we may be justified in holding a continuous hedge, but certainly it can be useful as a short term hedge regardless.
Indeed, I am concerned about oil getting too close to $50 and triggering a massive fall below $25. I believe such an event would take a big bite out of TSLA prices as happened earlier this year. So this is a specific short term risk that leads me to accumulate a hedge against. In fact, I bought more SCO today and the value if my hedge is now about 2.6% of my Tesla holding. I plan to buy more hedge as oil creeps up to $44 and $46. I may even over-hedge if oil goes to $50. April 17 will probably lead to a collapse of oil, if this run up continues.
