Nikola: Hitching A Sustainable Trade to Ride Through the Hype

Zero-emissions truck company Nikola (NKLA) has been a short-seller’s dream for almost two months given the pressure from sellers and a rapidly expanding float. As a pre-revenue company with no product in the market and a multi-billion dollar market cap, Nikola naturally attracts a lot of scrutiny. I finally got interested in the company and the stock after listening to a revealing interview with Nikola’s founder and executive chair, Trevor Milton, on “This Week in Start-Ups” hosted by Jason Calacanis and aired on July 31, 2020.

Milton’s interview included hints of news to come and provided insights into how Nikola intends to manage its stock and investor base. For example, Nikola World 2020 is fortuitously timed to start just as major lock-ups on insider shares expire on December 3rd (Seeking Alpha contributor Henrik Alex provides details on the lock-ups). If stock market history is a guide, then I strongly expect that NKLA will at some point soon break out of the current stranglehold of selling and rally in giddy anticipation of the product news from this event. With no hard financials to report, Nikola might drop some of the news in its earnings report on August 4th.

During the interview, Wilson tantalized with a pending announcement about an OEM partner to build the Badger pick-up truck.

Wilson stated that Nikola already has three offers on the table. The company just needs to sign an offer; Nikola may not even pick the OEM offering the most money. Wilson confidently proclaimed: “We are going to look really good.” A well-known, trusted OEM would lend Nikola and the Badger a lot of credibility and build a lot of anticipation for Nikola World 2020. In other words, at any time, Nikola could release big news with enough powder to send the stock upward again.

Wilson also spoke about getting the first battery semi-truck on the road ahead of competitors. Nikola has five of these trucks coming out of the Iveco manufacturing facility in Ulm, Germany. Wilson declared after that rollout comes “hundreds” and after that “thousands.”

All this talk of battery-based trucks followed an extensive description of Nikola’s hydrogen-based business model. Wilson described a market $1 trillion in size for moving weight-sensitive freight over long ranges. Nikola is working on an infrastructure of hydrogen filling stations for standard freight routes that keep the infrastructure busy and keep costs down. Nikola charges companies by the mile in a package that includes the truck, fuel, warranty, and maintenance. Nikola expects to make $250K per truck whereas the diesel industry, like a Peterbilt, earns only $15K per truck.

As host Calacanis noted, this endeavor alone is large enough for a small company (about 400 employees), so why bother with all the other bells and whistles? Wilson’s main answer: retail investors. Wilson concluded that Nikola cannot grow to a $500B to $1 trillion company in 10-15 years without retail investors. He even described the SPAC (Special Purpose Acquisition Company) as a way to grant retail investors more access to future upside.

Wilson explained that 90% of Americans will never own a semi-truck, so the average retail investor will never notice Nikola without consumer products. Wilson likened the investing theme to Apple and Google which have products that retail investors can touch and experience.

This kind of pitch for and to retail investors sounds very promotional. The Badger pick-up truck is supposed to bring in 25% margins at a $60-90K price tag. That kind of business should speak for itself. Retail investors are not necessary to create or implement the business model. However, of course, retail investors can help build hype and run prices up the flagpole.

Wilson even offered advice to retail investors. He complained that his generation and the one coming behind are overly focused on the short-term. They only care about the next 3 days when they should look to the long-term. He called the long-term “six months.” Times have really changed over the generations. Long-term used to come in units of years; the IRS considers an investment long-term after 1 year. To layer on the irony, Wilson beseeched the “Robinhoods” to invest like Warren Buffett to give time for a company (like his) to execute. Buffett ostensibly measures long-term somewhere close to forever.

Regardless, six months provides plenty of roadway to hold up the stock through Nikola World.

The Trade

While Nikola justifiably attracts skepticism and wariness, the company still harbors upside potential if it can deliver on even half (a quarter?) of its enormous promises. Determining a risk-appropriate price for a company that has yet to prove anything except its ability to promote and play the game of financial engineering is near impossible. Pricing is mostly about guessing what the market is willing to pay for this kind of risk. This wild stock chart says the market has no idea yet – and understandably so!

Two main trading options exist: 1) ignore Wilson’s plea and hold the stock very short-term, like 3 days, for very specific entry and stop-loss points (also known as the swing trade), and/or 2) create a hedged way to hold through important milestones.

Option #2 uses a combination of shares and options. When NKLA closed at $30 last Friday, a collar position looked very attractive with 100 shares covered by a short January, 2021 $35 call option and further hedged by an October $20 put. The extreme volatility in NKLA makes the options expensive and attractive for strategies that (on net) sell premium. This collared position caps the upside with an even tighter downside risk. In other words, this position is a low-risk, low-greedy way to participate in some upside if it materializes over an extended time horizon. The setup also makes money if the stock goes nowhere and leaves the holder the option to continue holding shares beyond expirations.

At the close on Friday, the Jan $35 call sold for around $7.00. The short call effectively protected the 100 shares bought at $30/share down to $23/share. The $2 on the October $20 put paid for more protection starting at $18 through expiration. The window of price risk sat between $18 and $23; the approximate $500 of risk offered $1200 of upside. The upside is capped by the profit from the price of the shares to the strike price of the short call option plus the premium of the call option. Note all valuations are approximate given transaction costs and the changing value of the options over time and volatility.

A time gap exists between October and January. If the Nikola World thesis pans out, then a rally should be well underway by October. The position could be closed at whatever profit the market offers at the time. Otherwise, a fresh decision awaits involving making one more withdrawal on the theoretical maximum profit to pay for two more months of protection.

This trade set-up applies across a spectrum of cases. Even with NKLA gapping up Monday morning, I was able to get this trade close to the Friday pricing. The trade looks good right before a high volatility event, like earnings, because there is extra premium to sell. NKLA’s 22% pre-earnings trade actually made the trade slightly more attractive with a setup at something like 100 shares at $36.49, short the Jan $40 call around $10, and long the October $25 put around $3.

Be careful out there!

Full disclosure: long NKLA shares, short NKLA call option, long NKLA put option