JPMORGAN: Tesla is facing a 'self-feeding downward spiral' — here's how to protect against a stock crash

Tesla Model S crash test

Tesla's stock price has taken a beating recently, falling almost 30% over a three-week period.
The equity derivatives team at JPMorgan has identified the perfect trade to hedge against the worst-case scenario of a Tesla stock crash.
Tesla's stock got some relief Tuesday morning after the company released first-quarter production results.
Watch Tesla trade in real time.

The past three weeks have been enough to worry even the staunchest Tesla bull, with the company's stock dropping as much as 27% to its lowest level in more than a year.

And it's really been a pick-your-poison situation. Perhaps the biggest concern for investors has been Tesla's slow pace of production for its wildly popular Model 3 sedan. Though the company's first-quarter report eased some worries of "production hell," the automaker's future is still highly uncertain.

Investors have also had to contend with the National Transportation Safety Board's newly announced second investigation into a crash involving a Tesla vehicle, as well as the suspension of the autonomous-driving programs at Nvidia and Toyota. And just last week, Moody's downgraded the company's debt rating.

Tesla enjoyed some relief from the bad news Tuesday after releasing production results and promising that it won't need to raise more money this year, but things could still turn dire, according to the equity derivatives team at JPMorgan.

The firm has outlined a worst-case scenario it says could be triggered by continued equity weakness. Among other things, JPMorgan is worried about the effect further Tesla stock losses will have on the company's ability to refinance the almost $1 billion of debt coming due in 2019.

"A continued stock decline could accelerate equity dilution concerns and create a self-feeding downward spiral in the stock, making our tail risk scenario plausible," Shawn Quigg, an equity derivatives strategist at JPMorgan, wrote in a client note. "We see a scenario where better than expected results may also no longer be enough to keep bullish investors engaged as the reward-risk dynamic appears to have deteriorated. We believe the market is underpricing Tesla tail risk."

Luckily, Quigg has a trade idea. And since the investment vehicles he's suggesting will be used to bet on a further Tesla stock plunge, he's labeled them "crash puts."

He recommends buying June puts with a strike price of $100. Further, Quigg says investors should consider funding the trade with the proceeds of a strategy he recommended early last week — which involved the sale of a calendar put spread.

Note that Quigg's trade would be "in the money" only if Tesla declines another 60% from today's levels, so it is very much a worst-case-scenario hedge.

But considering how Tesla has fared in recent weeks, it's starting to feel like a more distinct possibility.

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