Marijuana Is Moving Closer to Mainstream
Marijuana is likely to be one of the biggest leisure products of the next decade. But, for now, it is still in its infancy from a relative perspective. The industry is just coming out of its prohibition era and one thing that is needed is national distribution systems and the type of systems large companies have in place.
For at least one marijuana company, that is changing.
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Constellation Buys More Canopy
Canopy Growth Corp (NYSE: CGC) recently announced its beverage company partner Constellation Brands, Inc. (NYSE: STZ) is increasing its stake in the company to 38%.
Constellation sells a number of brands in the import and craft beer categories, including Corona Extra, Corona Light, Modelo Especial, Ballast Point and others. Other brands include Meiomi, Robert Mondavi, Wild Horse and others.
Shares shot higher on the news.
This could be the right company to take Canopy to the next level, so to speak.
Under the terms of the deal, Constellation Brands agreed to buy an additional 104.5 million shares of Canopy Growth for C$48.60 per share, expanding its stake in the marijuana company to 38% from the initial 9.9% acquired in November 2017.
All told, this means the company is going to make an investment of nearly $5 billion in the cannabis producer. The offer price of C$48.60 per share represents a 51.2% premium to Canopy’s market price the day before the deal was announced.
Additionally, Constellation Brands will receive 139.7 million new warrants of Canopy, which can be exercised in the next three years. These warrants, if exercised, will expand Constellation Brands’ ownership interest in Canopy to more than 50%, providing additional proceeds of about C$4.5 billion to Canopy.
Constellation Brands’ investment is now the biggest investment in the cannabis space.
Canopy plans to use the funds to expand in about 30 countries that allow medical cannabis while also laying the background for growth in new recreational cannabis markets. This will mark a solid expansion from Canopy’s current presence in 11 countries.
The deal is expected to close by the end of October 2018. That’s also when the legalization of recreational cannabis in Canada is expected to be effective. In the United States, recreational cannabis is permitted in nine states and the District of Columbia while it is an illegal drug at the federal level.
Analysts Like the Deal
Canaccord Genuity’s Matt Bottomley upgraded Canopy Growth from Hold to Speculative Buy and increased the price target for the company’s Canadian stock, which trades on the Toronto Stock Exchange under the symbol WEED to C$50.
Bottomley sees the investment as a “transformational event” for Canopy that allows the company to expand its platform. Canopy now has a dominant cash position in the Canadian cannabis industry, the analyst said.
“The company is substantially better suited to execute on a global first mover advantage with the capital and strategic leverage provided by Constellation.”
Looking ahead, Canopy is looking to expand in cannabis products in all channels, but the two companies will refrain from selling cannabis products in markets, where it is not legally permitted.
For a longer term view of the stock, we need to consider the Canadian listing.
Here we see a bullish pattern with the stock set to possibly clear resistance.
A Trade for Short Term Bulls
As with the ownership of any stock, buying CGC 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 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 CGC 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 CGC
For CGC, the September 21 options allow a trader to gain exposure to the stock.
A September 21 $40 call option can be bought for about $1.70 and the September 21 $45 call could be sold for about $1.05. This trade would cost $0.65 to open, or $65 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 $65.
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 CGC the maximum gain is $4.35 ($45 – $40 = $5.00; $5.00 – $0.65 = $4.35). This represents $435 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $65 to open this trade.
That is a potential gain of about 570% 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.