Another Potential Winner in Marijuana
Imagine getting in on a ground floor opportunity. Many of us hear about them all the time but rarely, if ever see them.
In the markets, a book called Market Wizards by Jack Schwager details the possible gains by getting in on the ground floor. The book interviews the world’s most successful traders. Many of them started in options when the markets were first introduced. Others pioneered futures trading.
The early adopters often ended up getting rich, and we recently saw this with bitcoin and other cryptocurrencies. The next big thing for investors might just be marijuana.
Another Trade in a Booming Sector
In recent days we have seen large companies like Constellation Brands, Inc. (NYSE: STZ) and Molson Coors Brewing Company (NYSE: TAP) announce plans to move into the marijuana business. This will be a small part of the operations of those giants.
Companies dedicated to marijuana are also making big moves. As MarketWatch.com recently reported, “Tilray Inc. (Nasdaq: TLRY) stock surged … after the Ontario Cannabis Store announced supply agreements with 26 licensed cannabis producers, including Tilray.”
Tilray priced its initial public offering at $17 just a few weeks ago, in late July, when it became the first cannabis company to IPO on the Nasdaq exchange. The stock opened up and after a recent pullback is at new highs.
Canada has legalized adult recreational use of weed and the new regime is set to roll out October 17. Other cannabis stocks that had reached agreements with the Ontario Cannabis Store such as Canopy Growth Corp. (NYSE: CGC) also rose on the news.
TheStreet.com added, “Tilray and Ontario Cannabis will offer an array of products, including pre-rolled joints, a women’s wellness brand that features sublingual drops and massage oil and CANACA — high-end Canadian cannabis that is offered pre-rolled or whole-flower.
Canada’s new cannabis rules legalize the drug in October for people 19 years and older. People will be able to use the drug in any private residence but not in any public places, workplaces or motorized vehicles.
Another major restriction is that unlike other municipalities in the United States, the Ontario Cannabis Store website will be the only legal option for purchasing recreational cannabis in the province.”
This should all be bullish for the stock.
A Trade for Short Term Bulls
As with the ownership of any stock, buying TLRY 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.
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 TLRY
For TLRY, the October 19 options allow a trader to gain exposure to the stock.
An October 19 $40 call option can be bought for about $5.25 and the September 21 $45 call could be sold for about $3.60. This trade would cost $1.65 to open, or $165 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 TLRY trade, the maximum loss would be equal to the amount spent to open the trade, or $165.
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 TLRY the maximum gain is $3.35 ($45 – $40 = $5.00; $5.00 – $1.65 = $3.35). This represents $335 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $165 to open this trade.
That is a potential gain of about 103% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
Now, this is the latest marijuana stock to make a big move. As we’ve said before, something massive – and potentially profitable – is about to happen. Because, Canada just announced that marijuana will be fully legal starting on October 17, 2018.
This time it’s for real. And it’s about to set off a firestorm.
Thing is, this is happening FAST. So it’s imperative you take action right away if you want in on this round of gains.
You don’t have to do any work either…