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Don’t Miss This Marijuana Trade

Don’t Miss This Marijuana Trade

To many analysts it seems that everything is lining up for a big boom in the marijuana industry. The demand for the product is in place and has been for many years in the unregulated market. Now, the regulatory environment is shifting and that creates opportunities in public markets.

It’s in some ways like the railroad boom of the 1800s or the auto industry in the early 1900s. There will be winners and losers and fortunes will be made by investors who get the analysis right. Just like in those earlier booms, consolidation could be important.

Based on that history, the latest news from one of the big companies in the industry could be especially important, and potentially bullish.

News From Canada

TheStreet recently reported,

Canadian marijuana producer Aurora Cannabis Inc. (NYSE: ACB) announced Monday that it was bolstering its presence in the western part of the country through the purchase of privately held British Columbia-based Whistler Medical Marijuana.

The companies have entered into a letter of intent that will see Aurora acquire all issued and outstanding shares of Whistler for about $175 million.

Whistler is one of Canada’s most recognized brands and is one of the country’s original 10 licensed cannabis producers as well as the first licensed producer to obtain organic certification.

“This transaction adds an iconic, organic certified BC-based brand with exceptional traction and a significant price premium in both the medical and retail markets,” said Terry Booth, CEO of Aurora.

“We intend to accelerate the completion of Whistler’s Pemberton expansion project, and leverage our domestic and international distribution channels to increase market reach for their exceptional products.”

Meanwhile, Whistler brass said it sees this as an opportunity to take advantage of Aurora’s increasing domestic and international reach.

“With its commitment to the highest product quality standards, as well as its large footprint in both the Canadian and international cannabis markets, Aurora is the ideal partner for Whistler to enhance our growth and margin profile,” said Whistler CEO Christopher Pelz.

Traders seemed to cheer the news and buying pressure pushed shares of ACB up on the news.

ACB daily chart

This rally comes as the stock bounces off of support and appears to be forming a double bottom on the chart, potentially setting up a run towards the old highs.

ACB weekly chart

But there are risks and a strategy to manage risk could be useful for any trade.

A Trade for Short Term Bulls

As with the ownership of any stock, buying ACB 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 priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for ACB

For ACB, the March 15 options allow a trader to gain exposure to the stock.

A March 15 $9 call option can be bought for about $0.43 and the March 15 $11 call could be sold for about $0.20. This trade would cost $0.23 to open, or $23 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 $23.

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 ACB the maximum gain is $1.77 ($11 – $9 = $2.00; $2.00 – $0.23 = $1.77). This represents $177 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $23 to open this trade.

That is a potential gain of about 669% 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.