It looks like the last people to cut Elon Musk a check are probably already ruing the day.
It’s been just a few weeks since investors lent Tesla TSLA, +1.43% another $2.35 billion to meet the electric-car company’s current cash crunch. And so far they’re down $370 million on the deal.
The stock and convertible bonds have slumped in the latest panic. The “conversion” feature on the bonds, which is supposed to give them extra value if Tesla stock ever gets near $310 again, already looks a little quaint.
Tesla’s latest stock price: $193. Oops.
Read: Is it time to revive the rumors that Apple will buy Tesla? At least one expert thinks so
Binary outcome
In the months ahead, these sorts of losses could start looking like peanuts. It seems like the long-awaited showdown between Musk and Wall Street has finally arrived.
This could be Mardi Gras for traders. There is a lot of money to be won — and lost.
Few companies have so many fans as Tesla. Or as many skeptics. And few valuable companies face such a binary outcome.
With tens of billions of dollars at stake, and Musk in the spotlight, expect plenty of fireworks.
Even at the latest stock price, Tesla’s equity is still being valued on Wall Street at a whopping $35 billion. That’s nearly $10 billion more than the value of Ferrari RACE, -0.38% a luxury car company that actually makes money. It’s nearly twice the value of Fiat Chrysler FCAU, -2.30% and almost as much as the value of 116-year-old Ford F, -1.20%
For a company supposedly at risk of implosion, that’s a lot of equity value. (Needed footnote: If Tesla actually defaults, the equity would almost certainly be worth zero.)
Meanwhile, the bond market is now putting about a 30% probability on Tesla defaulting on its debts at some point during the next six years.
Creditors are now demanding an astonishing 9% a year interest to compensate for the risks of lending to the company till 2025. That’s nearly four times the so-called “risk-free” interest rate on equivalent Treasury bonds.
It’s about as bad as it sounds.
Read: Fans of Tesla’s stock might find the car maker’s bonds a profitable investment
The trade
The real action is going to be in the options market, as usual. This is where anyone, even a retail investor, can make big money on fast moves. If you think Tesla is either going to $0 or $1,000, this is where to bet.
And it sets up intriguing two-way wagers.
The bonds, for example, offer a 50% return if the company avoids default.
But some of the equity options offer huge payouts if it doesn’t.
“Put” options, or “down” bets, on the stock can pay out seven to one or more if the company defaults and the stock goes to zero. For instance, the $50 puts, good till January 2021, cost $6 a share and will net you a $44 profit if Tesla ends up at $0 by then.
Bottom line: Buy the bonds, buy the puts, and there’s a very good chance you’ll make money either way.
Of course, if you want to be the real “smart money,” you can’t just make the trade.
You have to make it with other people’s money. Leveraged 10 to one.
Oh, and throw in a sweetheart profit-sharing contract, and a giant, egregious tax loophole, as well.
Brett Arends is a MarketWatch columnist.