The market is ending this wild week that saw all-time highs in both the S&P 500 and the Dow with a bit of a pause… a calm before the storm.
The stock market has been in a fury over rate cuts, geopolitical tensions and of course trade negotiations. But now, it has decided to go quiet this first day of summer. All except cannabis stocks… specifically industry leader Canopy Growth (CGC).
The pot giant announced its most recent quarterly earnings and gave investors plenty to chew on. Revenues surpassed expectations at $94.1 million during the fourth quarter compared to the estimated $92.6 million. But that success didn’t filter the whole way through the income statement.
Earnings missed in a major way. Canopy reported a C$0.98 per share loss during Q4, compared to an estimated loss of just C$0.32. That has shares of CGC reeling today, down 7.37% as I write.
Now, this week hasn’t been a complete flop. The company was able to get its proposed takeover of Acreage Holdings through a shareholder vote. The problem, however, was that during its quarterly announcement, it did note that the deal will have a negative impact on this current quarter’s financials.
Cannabis investors, if you can’t tell already, are a bit impatient. While many longer-term investors have started piling into the likes of Canopy and Aurora Cannabis – and others at the top of the industry – there’s still a disproportionate share of speculators attached to these names.
You can see just how wild CGC shares have been this year:
And this is the industry leader! As you can see, even after its massive rally to begin the year – shared by all of its peers too – Canopy has traded between $40 and $52 throughout 2019, a rather wide trading range.
But this does gives us a unique trading opportunity ourselves. You see, each time CGC shares have dropped, it has tested the $40 mark. For only one day since January has it dropped below that price point… and only for a day. That’s the key support we’ll be playing here.
As investors take this weekend to collect themselves and look beyond this single earnings announcement, they’ll see that sales are still growing at nearly 200% and the company’s cash position is immaculate at $4.5 billion.
That’s true acquisition and expansion ammunition even if the Acreage Holdings deal takes longer than expected. Remember, that major deal – which would allow CGC to overnight expand rapidly into the U.S. marijuana industry – will only go through when the U.S. federal government decriminalizes or legalizes pot.
Of course, Canopy doesn’t have to wait to get its roots into the world’s largest cannabis market. In fact, the company has already set course to either grow at or contract out hemp properties in seven states in the U.S. This gives the company one of the largest CBD footprints in the industry.
So, with a weekend separating this financial announcement and Monday’s trading, we should be looking at another bounce back from this crucial $40 mark.
But that doesn’t necessarily mean that shares will skyrocket from here either. This could be a soft bounce as long-term investors consolidate their position.
Fortunately, there’s a great way to play just such a scenario…
A Strategy For a Soft Bounce
A bull put spread is a type of options trade that involves selling a put option on a stock you believe will either bounce higher or remain the same and buying a second put with a lower strike price.
This results in a net credit, meaning you earning income at the start of the trade. Unlike most other investment strategies, your maximum profit potential starts in your hands rather than relying on price action to achieve.
In other words, that profit, which you collect right up front, can only be taken away if shares fall through the strike price of the sold put.
As noted, $40 is the key price point for Canopy. So, that’s the strike price that makes the most sense.
You can see how this kind of trade works here:
Source: The Options Industry Council
As you can see, your maximum potential profit using this strategy is capped (the amount you receive right at the start) but so is the amount at risk. Since this type of trade involves buying a put with a lower strike price, losses are capped at that price.
Let’s look at a specific trade on CGC to show you a bull put in action.
A Specific Trade on CGC
Right now, a trader can sell an August 16 $40 put for $3.46 per share and buy an August 16 $37.50 put for $2.24 per share for a net credit of $1.22 per share. Since each trade is worth 100 shares of CGC, that’s an upfront payment of $122.
That $122 goes directly into the trader’s account at the beginning of the trade, hence the net credit. That’s also the total maximum profit potential of the trade. The amount at risk is a bit higher… but much less likely.
To find what’s at risk with this trade, take the difference in strike prices ($40 – $37.50 = $2.50), and subtract the credit ($2.50 – $1.22 = $1.28). On 100 shares that’s $128 at risk for the full two months of this trade.
Now, the only way the trader would lose that full $128 would be if shares of CGC fall both below their support at $40 AND the $37.50 mark. They haven’t traded that low since January. And the company has become so much more exciting since then.
As investors consider what to do over the weekend following this earnings announcement, they’ll come to the same conclusion they had back then: Canopy is making all the right moves and growing at an incredible rate for an industry leader.
Note that shares don’t have to rally from here. They don’t have to go up a single cent, in fact. Actually, they have room to even fall a few cents from here… and this trade will still result in a full maximum profit of $122.
And if that doesn’t sound like much. Consider this. That $122 represents a potential return of 95.3% on the amount at risk. And again, shares don’t have to do anything to collect it.