Triple Digit Income Is Possible Even as the Fed Cuts Rates
Traders know that interest rates are low. A popular theme in articles about income investing is that interest rates are at 5,000 year lows. Even Greece, the country that was at the center of the latest financial crisis in the Euro Zone, was recently able to sell government securities at negative interest rates.
This news, and the economic environment, makes income difficult to find. However, there are strategies available to investors willing to use options. One idea is to jump into trades that are risky, benefiting from possible declines.
An example, as The Street reported, is in a volatile sector,
“A Jefferies note suggested that near-term risk in the cannabis sector has heightened, given numerous recent negative headlines and few signs of profitability.
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Analyst Owen Bennett cut his price targets across the sector by an average of 50%.”
This downgrade comes as the stock is in an extended down trend.
Canopy Growth Corporation (NYSE: CGC) engages in engages in production, distribution, and sale of cannabis in Canada. It operates through two segments, Cannabis Operations and Canopy Rivers.
The company’s products include dried flowers, oils and concentrates, softgel capsules, and hemps. It offers its products under the Tweed, Spectrum, DNA Genetics, CraftGrow, Tokyo Smoke, DOJA, Van der Pop, and Maitri brands.
The company also provides growth capital and a strategic support platform that pursues investment opportunities in the global cannabis sector.
Canopy Growth Corporation has a clinical research partnership with NEEKA Health Canada to investigate the efficacy of cannabinoids for the treatment of post-concussion neurological diseases in former NHL players; partnership with Parent Action on Drugs; and a collaboration with Cure Pharmaceutical Holding Corp. for the development of low-dose cannabidiol oral thin films.
“We think [the consensus] may be expecting too much sequentially from names in a market where growth is not significant (yet), some capacity is set aside for extraction, and costs are increasing on derivatives prep,” Bennett wrote.
Bennett downgraded Canopy Growth (NYSE: CGC) to underperform from hold and cut his price target to C$25 from C$77. He calls Canopy “the most expensive name across the space (even with the recent selloff).”
And while Canopy “continues to have material potential long term, signs of share pressures in Canada, near-term weak gross-margin/profit performance, lack of material catalysts, and question marks over how successful beverages will be” prompted the downgrade.
The stock is now near support and a break could send the price down sharply.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in CGC
For CGC, we could sell a November 15 $17.50 call for about $2.72 and buy a November 15 $20 call for about $1.44. This trade generates a credit of $1.28, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $128. The credit received when the trade is opened, $128 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $122. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($128).
This trade in CGC offers a potential return of about 104% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if CGC is below $17.50 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $122 for this trade in CGC.