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Cannabis Stocks are Soaring, Options May be Your Best Bet for Profits
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“What’s that? Then sell, sell, sell…Everyone’s selling? Then buy, buy, buy!”
-Al Czervik
The boorish real estate developer played by Rodney Dangerfield in the 1980 film Caddyshack was also the ultimate contrarian trader, instructing his broker on a cell-phone call from the golf course to do the opposite of what the Wall Street herd was doing. It’s a comic moment in a farcical movie, but the concept of “fading the move” is an important strategy to consider.
Cannabis stocks have been on a tear lately with some companies gaining more than 50% in a single trading session on Tuesday. On one hand, the rally over the past several weeks seems to represent pent-up demand and increased optimism about the prospect of federal legalization in the US. On the other hand, the meteoric rise over just the past few days is more likely the result of cannabis stocks getting increased attention from the Reddit crowd that took GameStop (GME - Free Report) , AMC Entertainment (AMC - Free Report) and other heavily shorted stocks to dizzying heights (and back) just a few weeks ago.
For serious long-term investors, that price volatility isn’t necessarily desirable - even when it results in immediate price gains.
The rally probably leaves you in one of two camps. Someone who already owned shares in one of more cannabis companies who is trying to figure out whether it’s a good idea to sell now to lock in some of the terrific gains those stocks have just made. Or someone who’s been considering buying into the cannabis rally and is now forced to consider that you may have missed your opportunity to get in at reasonable prices.
Options can help you in either situation.
As we learned during the GameStop episode, call option buying is a major component in the rapid rise of the stocks that get hot based on internet-forum enthusiasm. The group of investors at Reddit’s Wallstreetbets make it clear in their posts that they are well-aware of the “gamma squeeze” effect that's created when they simultaneously buy shares and calls and send the market makers who are short options scrambling to buy shares at ever higher prices.
Another component of the Reddit rallies is that traditional short sellers are currently living in fear. Those who might otherwise be willing to provide liquidity during a rally by selling shares outright in the hopes of making a profits when they decline aren't participating. The prospect of being caught short in a stock that can rise 100% or more in a single day has kept all but the best-capitalized shorts on the sidelines. Many individuals and smaller institutions instead choose to buy limited-risk put contracts to establish a short position.
All that options buying pressure has sent implied volatilities soaring; and that could be just the opportunity you’re looking for. You want to sell options when implied vols are high.
I want to make it clear at this point that I am not – and will never – recommend selling uncovered call options. The losses in that trade are technically infinite. The strategies I’ll describe contain maximum calculable risk.
Should I Sell My Shares Into the Rally?
Even if you’re a long-term cannabis bull, you might be tempted to sell your shares into such a spectacular rally out of fear that when the music stops, you will have missed your chance to grab those profits for years – or forever. In the Marijuana Innovators Service, I recently advocated for selling a small portion of rapidly appreciated shares to lock in profits, rebalance your total portfolio and maintain objectivity during a move in the stocks that doesn’t always make rational sense.
I stand by that advice, but there’s also another trade that makes sense – selling calls against those shares. With implied volatilities soaring, the premiums you’ll receive compared to just a few weeks ago are huge.
If the stocks continue to rally, you’ll end up selling the shares you sold calls against, but it will be at a higher price that where the shares are currently trading in the market, plus you’ll keep that juicy premium, further increasing your proceeds on the transaction.
If the rally stalls, you’ll still own all of the shares you intended to hold for the long-term, plus you’ve got some cash in your pocket when those calls expire worthless.
Just as selling a portion of your shares was a good idea, you don’t need to sell calls against all of your holdings. If you own more than 100 shares, you can sell calls against only a portion of your total position.
I Missed the Boat, Should I jump on Now?
Those who have been waiting on the sidelines for confirmation that the cannabis rally is the real deal are now looking at a batch of companies that have doubled or tripled in a short period of time and wondering whether they’re still a good long-term opportunity.
Piling into the shares now represents the risk of “buying the high” and owning at a price basis that may take some time for the companies to grow into on the fundamentals. Maybe you’re thinking that if you can just get a little pullback in the shares, that will be the time to buy.
Once again, a reasonable answer is selling those expensive options. If (and only if) you have the capital ready to deploy to buy the shares, you might consider selling puts instead.
If the price declines, you’ll get assigned on the short puts at expiration and buy the shares at the strike price – which is lower than the current price. Plus your price basis will be reduced even further by the option premium you collected.
If the shares continue to rally, you will miss the opportunity, but you’ll have some extra cash to pursue other trading ideas. (This is not the last torrid rally you’re ever going to see…)
In either circumstance, understanding the opportunity that high implied options volatilities represent can help you make sound entry and exit decisions during confusing times.
When the hordes are yelling “buy, buy, buy!” the smart move may well be doing the exact opposite.
-Dave
Want to apply this winning option strategy and others to your trading? Then be sure to check out our Zacks Options Trader service.
Interested in strategies with profit potential even in declining markets? Maybe our Short List Trader service is for you.
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Cannabis Stocks are Soaring, Options May be Your Best Bet for Profits
“What’s that? Then sell, sell, sell…Everyone’s selling? Then buy, buy, buy!”
-Al Czervik
The boorish real estate developer played by Rodney Dangerfield in the 1980 film Caddyshack was also the ultimate contrarian trader, instructing his broker on a cell-phone call from the golf course to do the opposite of what the Wall Street herd was doing. It’s a comic moment in a farcical movie, but the concept of “fading the move” is an important strategy to consider.
Cannabis stocks have been on a tear lately with some companies gaining more than 50% in a single trading session on Tuesday. On one hand, the rally over the past several weeks seems to represent pent-up demand and increased optimism about the prospect of federal legalization in the US. On the other hand, the meteoric rise over just the past few days is more likely the result of cannabis stocks getting increased attention from the Reddit crowd that took GameStop (GME - Free Report) , AMC Entertainment (AMC - Free Report) and other heavily shorted stocks to dizzying heights (and back) just a few weeks ago.
For serious long-term investors, that price volatility isn’t necessarily desirable - even when it results in immediate price gains.
The rally probably leaves you in one of two camps. Someone who already owned shares in one of more cannabis companies who is trying to figure out whether it’s a good idea to sell now to lock in some of the terrific gains those stocks have just made. Or someone who’s been considering buying into the cannabis rally and is now forced to consider that you may have missed your opportunity to get in at reasonable prices.
Options can help you in either situation.
As we learned during the GameStop episode, call option buying is a major component in the rapid rise of the stocks that get hot based on internet-forum enthusiasm. The group of investors at Reddit’s Wallstreetbets make it clear in their posts that they are well-aware of the “gamma squeeze” effect that's created when they simultaneously buy shares and calls and send the market makers who are short options scrambling to buy shares at ever higher prices.
Another component of the Reddit rallies is that traditional short sellers are currently living in fear. Those who might otherwise be willing to provide liquidity during a rally by selling shares outright in the hopes of making a profits when they decline aren't participating. The prospect of being caught short in a stock that can rise 100% or more in a single day has kept all but the best-capitalized shorts on the sidelines. Many individuals and smaller institutions instead choose to buy limited-risk put contracts to establish a short position.
All that options buying pressure has sent implied volatilities soaring; and that could be just the opportunity you’re looking for. You want to sell options when implied vols are high.
I want to make it clear at this point that I am not – and will never – recommend selling uncovered call options. The losses in that trade are technically infinite. The strategies I’ll describe contain maximum calculable risk.
Should I Sell My Shares Into the Rally?
Even if you’re a long-term cannabis bull, you might be tempted to sell your shares into such a spectacular rally out of fear that when the music stops, you will have missed your chance to grab those profits for years – or forever. In the Marijuana Innovators Service, I recently advocated for selling a small portion of rapidly appreciated shares to lock in profits, rebalance your total portfolio and maintain objectivity during a move in the stocks that doesn’t always make rational sense.
I stand by that advice, but there’s also another trade that makes sense – selling calls against those shares. With implied volatilities soaring, the premiums you’ll receive compared to just a few weeks ago are huge.
If the stocks continue to rally, you’ll end up selling the shares you sold calls against, but it will be at a higher price that where the shares are currently trading in the market, plus you’ll keep that juicy premium, further increasing your proceeds on the transaction.
If the rally stalls, you’ll still own all of the shares you intended to hold for the long-term, plus you’ve got some cash in your pocket when those calls expire worthless.
Just as selling a portion of your shares was a good idea, you don’t need to sell calls against all of your holdings. If you own more than 100 shares, you can sell calls against only a portion of your total position.
I Missed the Boat, Should I jump on Now?
Those who have been waiting on the sidelines for confirmation that the cannabis rally is the real deal are now looking at a batch of companies that have doubled or tripled in a short period of time and wondering whether they’re still a good long-term opportunity.
Piling into the shares now represents the risk of “buying the high” and owning at a price basis that may take some time for the companies to grow into on the fundamentals. Maybe you’re thinking that if you can just get a little pullback in the shares, that will be the time to buy.
Once again, a reasonable answer is selling those expensive options. If (and only if) you have the capital ready to deploy to buy the shares, you might consider selling puts instead.
If the price declines, you’ll get assigned on the short puts at expiration and buy the shares at the strike price – which is lower than the current price. Plus your price basis will be reduced even further by the option premium you collected.
If the shares continue to rally, you will miss the opportunity, but you’ll have some extra cash to pursue other trading ideas. (This is not the last torrid rally you’re ever going to see…)
In either circumstance, understanding the opportunity that high implied options volatilities represent can help you make sound entry and exit decisions during confusing times.
When the hordes are yelling “buy, buy, buy!” the smart move may well be doing the exact opposite.
-Dave
Want to apply this winning option strategy and others to your trading? Then be sure to check out our Zacks Options Trader service.
Interested in strategies with profit potential even in declining markets? Maybe our Short List Trader service is for you.