Trades

A Trade on this “Sindex’s” Big Week

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In a market full of IPOs, massive mergers and transformative industries like artificial intelligence, cryptocurrencies and cannabis stocks, the word conglomerate is actually an underutilized term. But there’s no better descriptor than that for the likes of Altria Group (MO).

Altria is an ancient corporation, with its main business once – and still – in tobacco. Its current form came about when it split off its international tobacco business into Philip Morris International. Altria retained its Marlboro brands in the U.S.

That was back in 2008. Today, Altria is much more than just the owner of Philip Morris products in the U.S. It has transformed into a modern day “sindex” (sin index) of companies.

Altria itself controls just over half of the cigarette sales in the U.S. It has heavy investments in smokeless tobacco, specifically through the popular Juul brand. It controls a 10% stake in AB InBev (Budweiser) and a 45% stake in Cronos Group – a medical marijuana company in Canada.

About the only thing it doesn’t have a hand in is casinos or horse racing. The company is the true definition of a vice conglomerate. Yet, it’s only been at this game for a few years.

The first of these major vice purchases was AB InBev in 2016. Since then, that company itself has been consolidating in its own industry, recently purchasing SAB Miller – the only other major brewer in the U.S. market.

But as you can see, this sindex style hasn’t yet turned into a major moneymaker for Altria investors:

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Despite some initial success as a vice conglomerate, MO share performance has ended up flat from where it started more than three years ago.

But you can see how choppy that trading has been, especially over the last year and a half. A lot of that is due not from the gradually declining tobacco sales Altria’s main industry is coming to know… but from movement from its “strategic investments” like alcohol and marijuana.

It would be a fool’s errand to try and predict how the next three years will go for these industries or for Altria itself. Stiffer regulation could hamper its major investments in vape products, Juul in particular. Or cannabis could luck into a full legalization in the U.S. Either would send shares of Altria flying in one direction or the other.

Fortunately, however, you don’t have to consult a crystal ball to play this unique sindex stock.

Window of Opportunity For Altria Traders

Just last week, AB InBev reported its second quarter earnings. The beverage giant announced its best volume growth in five years and earnings per share growth for the quarter of 15%. For a company many considered too slow and mature for surprises, it blew analysts away.

BUD shares spiked 6% immediately upon this news. But AB InBev wasn’t done. You see, the company has been contemplating a spinoff IPO for its Asian business, where sales have been very good with double-digit growth rates.

This spinoff was going to be a major cash cow for InBev to help pay down the company’s massive debt left over from its SAB Miller acquisition. But the company just pulled that IPO. Instead, the company’s CEO Carlos Brito secretly struck a deal to sell its Australian portion of this business to Asahi Group for $11.3 billion.

Surprising nearly everyone, investors have been enthusiastic. This puts cash in the company’s pocket to pay down debt, delays the uncertainty of an IPO on the Hong Kong market and lets it keep its fastest-growing Asian markets.

Altria as an investor itself saw its own shares jump on the news. This is what happens at conglomerates. They are massively influenced by what happens at companies they hold. So, when we look forward, we need to consider what’s on MO’s near-term calendar.

Not only does the company report its own earnings tomorrow, which will be an important marker on its own Juul sales path… but next week, its cannabis play will announce its results.

Cannabis stocks, if you’ve not been paying close attention of late, have been wild. Two of the larger players are facing enormous management shake ups. One – Canopy Growth – due to its own outside conglomerate pressure. The other – CannTrust – because of a terribly reckless mistake in not gaining growing approval from regulators.

Now, Cronos, Altria’s pot investment, is not under fire from those kinds of shake ups. But in this new and wild industry, it doesn’t matter. As you can see, just this year the company has traded as low as $10 and as high as $25:

Screen Shot 2019-07-29 at 6.18.29 AM

So, when it reports on August 8, you can expect another major price swing – one direction or the other. And the same goes for its largest investor… Altria.

Clearly, this is a crucial period for the sindex. Investors are still absorbing all that’s going on at InBev. They are gearing up for their own financial results. And then, one week later, Altria investors will have to consume Cronos’ financial picture.

In short, expect volatility. Again, it’s impossible to predict the direction all of this will send MO shares. But fortunately, smart traders don’t need to know that to make a serious buck out of all this.

A Strategy For Short Term Volatility

A long straddle is a type of options play that involves buying both a call and a put on the same stock, with the same strike price and the same expiration date.

That way, traders can benefit from price movement in either direction. If shares go up, the call churns a solid profit. If shares fall, the puts become the moneymaker.

The risk of this strategy is that shares don’t move at all. If that happens, both the call and the put fail to pay off the investment cost of the trade.

You can see how that plays out here:

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Source: The Options Industry Council

For a company like Altria, at a time like this, the idea of no price movement is almost absurd. Something will give with all of the earnings announcements and corporate shakeups going on right now.

Let’s look at a specific trade using this strategy on MO.

A Specific Trade on MO

Right now, traders could buy an August 16 $50 call on MO for $1.14 per share and an August 16 $50 put for $1.28 per share for a total trade cost of $2.42 per share. Since each contract is worth 100 shares of MO, that’s a net debit of $242.

That’s the most the trader has at risk for the three-week duration of this trade. Notice how short this trade is. That’s because it doesn’t need to be long for traders to see massive volatility in Altria. As noted, the company itself reports its second quarter numbers tomorrow. Cronos, its major cannabis investment, reports next week. Either or both could send shares flying in one direction or the other.

But that’s also the beauty of it. The higher they fly, the larger the profit on this trade becomes. You see, while the risk is limited to just the $242 it costs to open the trade, the profit potential is nearly unlimited.

The higher the stock price goes, the more money the call option will return. Likewise, the lower it goes, the larger the profit from the put option. In either case, the trader cashes out.

To find the point at which this trade turns into a profit, compare the strike price to the cost. For instance, if shares do rally, the trade produces a profit at $52.42 per share ($50 + $2.42 = $52.42). If shares fall, this trade enters profitability at $47.58 ($50 – $2.42 = $47.58).

In either case, that represents a price movement of just 4.8%. With so much going on for MO investors to deal with over the next week and a half, you can expect a movement much higher than that. And as noted, the greater the price movement, the higher the profit.

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