How to benefit from the rising vapors of cannabis

The cannabis market has been booming since August 15, 2018 when Constellation Brands Inc. announced a major $5 billion investment in Canopy Growth Inc. (WEED). Since then, the stock has shot up 132.6% from a low of $32.01, and it recently topped out at $74.45. Its closest competitor, Aurora Cannabis Inc., has ridden the same wave, climbing 77.3% from a low of $5.29 to a high of $9.38, for an increase of $4.09. The stock then stabilized and settled back down to its 20 and 50-day moving averages. In addition, its 20-day moving average has just overtaken its 50-day moving average. With the industry in such a strong bullish position, this price drop could represent an opportunity to adopt a low-risk bullish position since, if the upward trend continues, ACB may very well rise again by just as much. So we can set a target price of $12.03 by adding $4.09 to the stock’s recent low of $7.94. This target price also represents a zone of resistance at the point where the stock peaked in February and March of this year.

Daily Chart for ACB ($8.26 on Monday, September 10, 2018)

Chart of Aurora Cannabis Inc.

An investor interested in profiting from this scenario could buy call options expiring on December 21, 2018, choosing the strike that would yield the best return if the stock reaches $12.03 on expiration of the options.

We will choose from among the following call options:

• ACB 181221 C 7 at $2.25
• ACB 181221 C 8 at $1.75
• ACB 181221 C 9 at $1.40

Position

Comparative Table of Call Options

As the above table shows, given these three call options, it is ACB 181221 C 8 at $1.75 that gives the optimal combination of risk and return since it offers a potential return of 130.2% if ACB reaches our target price of $12.03 on December 21, 2018. We will therefore execute the following transaction:

• Purchase of 10 call options, ACB 181221 C 8 at $1.75
  • Debit of $1,750

Profit and Loss Profile

Target price on the call options ACB 181221 C 8 at $1.75 = $4.03 ($12.03 – $8.00)

Potential profit = $2.28 per share ($4.03 – $1.75), for a total of $2,280 

Potential loss = $1.75 per share (the premium paid) or $1,750

Intervention

Even though the target price for ACB shares is $12.03, our potential profit is tied to the $4.03 target price on the call options. So as soon as the price of the calls reaches this amount, we will liquidate the position, even if ACB has not yet reached the target price of $12.03. In the event that the stock takes a significant turn for the worse instead of continuing on a bullish trend, we will need to take defensive measures. So if ACB closes at below its 50-day moving average, this should be taken as a sign that the position is not heading in the desired direction, and the position should be sold.

Good luck with your trading, and have a good week!

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.