The marijuana market is smoking. Puns aside, there is quite a bit of money to be made from pot stocks, though picking the right one can be daunting. Recent legalization measures have turned companies like Tilray (NASDAQ:TLRY) into household names. Amid all the hype, however, my favorite investment remains Canopy Growth Corporation (NYSE:CGC).
There isn’t a lot that hasn’t already been said about cannabis stocks, or even CGC stock for that matter. Some analysts love the sector and Canopy Growth, and see significant opportunities for growth. Other, meanwhile, have likened the recent boom to the dotcom bubble.
There is certainly a degree of euphoria in the cannabis market right now. Companies across the board are rushing to invest in pot stocks to get a piece of the estimated $200 billion global market.
As proof of the market’s growth potential, even stateside, cannabis stocks had a breakthrough this week. The Drug Enforcement Agency (DEA) announced that it has moved some drugs with cannabidiol (CBD) to schedule V. This means that the U.S. government now believes those products have the lowest potential for abuse.
That opens the door for a number of pharmaceutical companies with cannabinoid products all ready to go. GW Pharmaceuticals’ (NASDAQ:GWPH) Epidiolex treatment for pediatric epilepsy comes to mind. But it also loosens the government’s grip on the cannabis market as a whole. The end result is inevitable at this point.
But these naysayers are missing the long game by focusing on the short-term cost. A common theme in today’s stock-buyback-driven market. Are some pot stocks like Tilray overvalued? Probably. But Canopy stock has had time to digest the Constellation Brands investment. The shares have leveled out and are now beginning to behave more rationally in an irrational market.
Click to Enlarge Technically, CGC stock is up nearly 100% in the past two months. The shares surged following Constellation’s investment, hitting a high of $56.60 in early September. Canopy stock has since entered a volatile consolidation pattern, driven by cannabis market speculation.
That said, support appears to be firming up in the $47.50 area, as you can see from the chart. What’s more, CGC’s 14-day relative strength index has fallen amid this volatility. In other words, the shares are now far from overbought and have plenty of room for additional buying before momentum becomes a concern again.
Outside of the financial headlines, sentiment on Wall Street remains thin on CGC stock. Specifically, Zacks reports that only five analysts currently follow Canopy, doling out four “buys” and one “hold.”
The average consensus price target rests at $40.18. With the bullish bandwagon far from full, there is room for both initiations and price-target increases. More development’s like the DEA’s announcement this week should bring more bulls to the table.
Finally, CGC’s options backdrop is also quite cautious. Currently, the October put/call open interest ratio comes in at 0.98. In other words, bearish puts are practically as popular as bullish calls on Canopy stock.
So, there is room for sentiment to grow more bullish (despite the gushing in the financial headlines), and there is room for CGC stock to rally. But just how high can Canopy rise over the short-term?
CGC options traders can provide some insight on that … and the results are just as volatile as you’d expect. At last check, October implied volatility was pricing in a potential move of roughly 40% for Canopy stock! That puts the potential upside near $57.87 and the potential downside at $40.97.
2 Trades for CGC Stock
Call Spread: Not only is the expected move big, but CGC options are expensive right now. As such, traders looking to jump into an options position on Canopy stock will want to proceed with caution.
If you’re still with me, then the Oct $50/$55 bull call spread has potential if you can stomach the risk. At last check, this spread was offered at $1.60, or $160 per pair of contracts. Breakeven lies at $51.60, while a maximum profit of $4.31, or $431 per pair of contracts — a potential return of about 100% — is possible if CGC stock closes at or above $55 when October options expire.
Put Sell: For those Canopy stock bulls looking to snap up the stock on a pullback, a put sell position can accomplish that and get you paid while you wait. Given market volatility, the Oct $41 put looks like a good place to start.
At last check, this put was bid at 96 cents, or $96 per contract. If CGC falls below $41 by expiration, you could be assigned 100 shares of Canopy stock for $41 each for every put sold. This is the end goal of this trade — buying CGC at a significant discount. And, remember, you were paid $96 per contract just to wait for the pullback.
On the other hand, if CGC does not trade below $41, you still keep the $96 premium and can try again next month. Repeat as needed to collect income or snap up Canopy at prices we probably won’t see for a long time as the cannabis market expands rapidly.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.