Amid all the ruckus of 2018 an investing thesis has emerged that has taken Wall Street by storm: Marijuana stocks surged almost like bitcoin did in its heyday.
There was extreme exuberance stemming from the legalization of pot in Canada and marijuana stocks like Canopy Growth (NYSE:CGC) and Tilray (NASDAQ:TLRY) were rocket ships that seemed unstoppable. TLRY especially was a short stock nightmare as it became difficult to trade even through options. I was lucky enough to ride perfectly through long calls and short puts and it was still tough to fill my winning orders.
Now that the event has passed, the trade becomes more fundamental than gambling. And therein lies the opportunity.
The concept is viable. Use of pot will increase because now, as the legalization trend propagates, millions more potential users will access it. Moreover, the applications will become more user-friendly. It’s a lot easier to justify trying it in an edible format than in a bong.
But the real buzz is around the potables. The concept of drinking cannabis at a party in lieu of some alcohol got the interest of major brewers. Consider the investment of Constellation Brands (NYSE:STZ) into CGC for example. And consensus is that they are not alone. The concept is plausible and could have legs. It is worth a bet for the long term.
The short-term trade in marijuana stocks won’t be easy as they are essentially momentum stocks on drugs; they move faster than even the traditional momo stocks like Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN). So it would be wise to take small tranche positions so that you don’t just lay the bet on one perfect entry point.
With that in mind, here are three marijuana stocks to buy.
Canopy Growth (CGC)
First, when considering marijuana stocks to buy, I want to leverage others’ homework. The aforementioned Constellation Brands did its due diligence on Canopy Growth before it invested $4 billion in it. So I am comfortable joining them in their bet on CGC stock. The thesis is easy for Canopy; if I am to risk money on an unproven concept, I want to do it in the one that has a fortress balance sheet. This way management can implement on plans without the risk of further dilution or insurmountable hurdles.
I’ve seen the CEO in several interviews and he has been consistent in his message. So it sounds like CGC has good plans to open up more markets to follow the legal path expansion. The U.S. market is perhaps the closest carrot to them and they have that proximity advantage.
ETFMG Alternative Harvest ETF (MJ)
Second, I would do a blanket bet on the rest of the sector with the ETFMG Alternative Harvest ETF (NYSEARCA:MJ).
Using this exchange-traded fund, I would add to my does of CGC stock, as it is 10% of the composition, but I would also capture investments in other promising marijuana-based companies like GW Pharmaceuticals (NASDAQ:GWPH). If the bullish thesis for pot were to materialize as expected, then those companies will be at the forefront.
My third pick on this list of stocks to buy is the wildest of the bunch: Tilray. The stock price action in TLRY stock can be nauseating, so it’s not for the faint of heart. In fact, TLRY is so risky that I don’t want to flat-out buy it here and hold it hoping for the best.
Instead, I would rather use options, where I can risk less and still participate in the upside. There are earnings coming up soon and a lock up expiration in January. So timing is important, but so is the level.
In this case, I want to sell the Dec puts at $62.50 and collect $3 per contract to open the position. If TLRY stays above $62.50 by mid Dec, then I keep my maximum profits. Otherwise, I own the shares at $62.50 and my breakeven point would then be $59.50 per share. Compare that with owning the shares at $102 and suffering the $40 loss.
The Bottom Line
When looking at potential marijuana stocks to buy, it’s important for investors to remember that there are many ways of trading a concept and not one method is perfect. I choose one that fits my investment style and current portfolio. Also, there are no guarantees when investing in stocks … this is even more true when betting on an upcoming concept like cannabis stocks. In situations like this, it’s important to consider size and never bet more then you can afford to lose.
Click here for more of my market thesis and get an ongoing free copy of my weekly newsletters.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on Twitter and Stocktwits.