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An Option on a Marijuana Stock Could Boost Your Gains

An Option on a Marijuana Stock Could Boost Your Gains

Marijuana is likely to be a volatile and potentially profitable sector throughout 2019. This is especially true as legal changes continue to expand the potential market. This expansion, being driven by news is likely to continue being volatile.

An example of the volatility can be seen below, in the chart of Cronos Group Inc. (Nasdaq: CRON), a stock which more than doubled in a month before pulling back.

CRON daily chart

In a recent article from GlobeNewswire it was reported that Investorideas.com, a leading investor news resource covering hemp and cannabis stocks released a 2019 outlook for the sector as the 2018 US Farm Bill law plants the seeds of a new era for the US markets.

According to New Frontier Data, “The 2018 Farm Bill will restore industrial hemp to nationwide legal production for the first time since World War II, offering vast opportunities for the industry and investment in a market expected to triple in four years.”

With the removal of hemp from federal prohibition under the Controlled Substances Act of 1970 (CSA), the total U.S. hemp industry now looks to expand at a healthy 18.4% through a 5-year combined annual growth rate (CAGR) from 2018-2022.

New Frontier Data’s Hemp Business Journal estimates that, in leading all hemp product categories, the hemp-derived CBD market will grow from a $390 million-dollar market in 2018, to a $1.3 billion market (or 3.3x) by 2022, representing a 27.2% 5-year CAGR.

Bruce Linton, Chairman & Co-CEO, Canopy Growth Corporation, the world’s largest diversified hemp and cannabis company, (TSX: WEED) (NYSE: CGC), commented on the passage of the Farm Bill saying:

“Canopy Growth commends the United States government for passing the Farm Bill, a transformative piece of legislation that will create jobs and meaningful economic impact across the United States.”

Thanks to a deep hemp-specific portfolio of intellectual property acquired from Colorado-based ebbu Inc. and a landmark investment of USD $4 billion from Constellation Brands, management believes it is well-positioned to enter the US market quickly.”

Companies are now looking to learn from experience, especially from the experience of the heavily regulated tobacco industry.

Cronos Group’s CEO Mike Gorenstein said, “Sure. I think any market, it’s great being able to draw from that experience.

One of the things that we found is going to be really important is the experience that Altria has dealing with agencies like the FDA and making sure that, again, we follow all the steps, we follow the right processes to make sure that we’re bringing products on in a responsible fashion and in collaboration with regulators. So I think that will be very, very important for us.”

That attitude could push Cron to new highs.

CRON weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying CRON could require a significant amount of capital and exposes the investor to standard risks of owning a stock.

To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.

Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.

To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.

This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.

bull call spread

Source: The Options Industry Council

Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

This strategy could be especially appealing with high prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for CRON

For CRON, the February 15 options allow a trader to gain exposure to the stock.

A February 15 $13 call option can be bought for about $0.55 and the February 15 $15 call could be sold for about $0.25. This trade would cost $0.30 to open, or $30 since each contract covers 100 shares of stock.

The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $30.

The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.

For this trade in CRON the maximum gain is $1.70 ($15 – $13 = $2.00; $2.00 – $0.30 = $1.70). This represents $170 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $30 to open this trade.

That is a potential gain of about 466% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.