Marijuana Stocks Offer an Opening for Traders
The news is official now with marijuana legal in Canada. And, with legal status comes a host of regulations. MarketWatch reported on some of the rules and the complications with initial compliance,
“To sell any marijuana product in Canada, the government requires a tax stamp on the package, but the stamps are only available from a single licensed vendor, the Canadian Bank Note Company Ltd., or CBNC.
Once the pot producers dealt with CBNC to receive their stamps, they were likely dismayed to find that the stamps had no glue on them — and there was only one company in Canada that could affix glue to the stamps.”
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“If you didn’t book your time six months ago with the one company in Canada that puts the glue on them, then you’re in trouble,” Tilray Inc. Chief Executive Brendan Kennedy told MarketWatch. “I don’t even know what you do.”
“It’s six months (from) when you plant a seed to when you ship it to the [Ontario Cannabis Store] if everything is perfect, if everything is spot on,” Tilray’s Kennedy said. “So there’s not a whole lot I can do today, it just wouldn’t make much of a difference. Were we frantic six months ago? Yes.
And certainly there were spots along the way where we had to do things in order to be prepared.”
Tax stamps were just one issue in the new market. Supply was another.
“In Ontario, Canada’s most populous province, three sources with knowledge of sales told MarketWatch that the province’s online store — the only way to legally buy weed there, since it will not allow retail sales until next year — had run out of product on Wednesday, the first day of sales.”
But Ontario Cannabis Store spokesman Daffyd Roderick said over the phone Thursday morning that there was plenty of supply remaining. Roderick declined to allow MarketWatch to interview executives at the OCS, nor provide sales figures for the first several days of sales.
“The OCS will not be releasing statistics at this time,” he wrote in an emailed statement. “We will say that the response to cannabis legalization has resulted in a high volume of orders.”
Some stocks of major companies in the sector pulled back after legalization. This includes shares of Canopy Growth Corporation (NYSE: CGC).
On the longer term chart, CGC is now at support.
This pullback could offer a buying opportunity, or it could be a chance to implement other bullish strategies.
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 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 priced 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 November 16 options allow a trader to gain exposure to the stock.
A November 16 $42.50 call option can be bought for about $3.90 and the November 16 $45 call could be sold for about $2.95. This trade would cost $0.95 to open, or $95 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 $95.
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 $1.55 ($45 – $42.50 = $2.50; $2.50 – $0.95 = $1.55). This represents $155 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $95 to open this trade.
That is a potential gain of about 163% 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.