Pot stocks like Canopy Growth Corp (NYSE:CGC) took flight after Democrats swept the November election. And the ascent lasted for multiple months. The narrative was seductive for CGC stock. A weed-friendly administration would pave the way for widespread legalization. As the total addressable market expanded, so too would the profit potential for CGC and friends.
Unfortunately, as is often the case with starry-eyed investors, they got too far out over their skis.
We’ve been witness to their comeuppance ever since the early February earnings report injected a nasty dose of reality into the situation. Prices are now more than 50% off their peak. If you want a silver lining, it’s that Canopy shares are still 10% up on the year. Though, it certainly doesn’t feel like it. Plus the lion’s share of recent entrants into the Canadian cannabis company likely arrived at higher prices and are now underwater.
Before revealing my bearish trade idea for CGC, allow me to point out two essential takeaways from the latest turn in the pot stock saga.
CGC Stock: Lessons From a Pot Stock Gone Poof
I can think of many lessons to extract from CGC stock’s recent behavior, but here are the two that speak the loudest.
First, when perception outpaces reality, quarterly earnings reports are usually the catalyst for rapid repricing. Holding a speculative stock that just doubled or tripled in a single bound into the announcement is highly, highly risky. So ring the register, take partial profits, buy protection, or take other actions to protect your hard-fought gains.
No one could have predicted that CGC would crash 50% in the aftermath of its Feb. 9 earnings report. But given how red-hot its share price was and how many gains had been priced in, it wasn’t a stretch to assume the earnings report would be underwhelming in light of what was priced in.
Second, volatility and momentum slice both ways. When you’re riding them higher it’s wonderful. But when the tide turns, watch out below. If you’re buying CGC stock, you better decide ahead of time if you’re a long-term investor or a short-term trader. If you’re the former, then buy few enough shares that you can ride out the crashes that will strike along the way. If you’re the latter, then get the heck out of dodge when the trend turns.
With both lessons properly extracted, let’s move on to the current price action and how to profit from it.
The Trend Is Down for Canopy Growth Stock
Prices are trending lower beneath a falling 50-day and 20-day moving average. The downside momentum has slowed slightly, but it was inevitable after the avalanche of selling that struck following February’s disastrous earnings report. The 200-day moving average is rising closely beneath, but I ultimately think we crack it and move lower.
The last two bounce attempts were rejected at the 20-day, and the current one looks no different. This morning’s 4.5% drop could be signaling the beginning of the next down-leg is upon us.
Long puts or put spreads look tempting here. I prefer the spread route since it carries less risk. It also opens the door to the possibility of holding into the next earnings report without getting slammed by volatility crush like the long put would.
The Trade: Buy the June $27.50/$22.50 bear put spread for $2.10.
The max loss is limited to your initial trade cost and will be forfeited if CGC sits above $27.50 at expiration. The max gain of $2.90 will be captured if prices fall below $22.50 by expiration.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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