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With cannabis stocks in the news this week, we’ll reveal what the options market expects in terms of future stock moves, and how options can play a role in potential short-squeeze situations.
Using Tilray, Inc. (NASDAQ: TLRY) as an example, we’ll also look at how spreads could be used in a high-end environment to reduce capital spending – whatever your trading outlook is.
Presentation and expected movements
First, a comparison of some of the moves expected over the next month for Tilray, Canopy Growth Corporation (NASDAQ: CGC), Aurora Cannabis Inc. (NYSE: ACB), Aphria Inc. (NASDAQ: APHA) and Cronos Group Inc. (NASDAQ: CRON) via the AI options calculator
With Tilray (TLRY) Trading around $ 55, the options market is pricing an expected move for the month of over 60% in either direction. (Note – the company must report its results the first week of March). The move being valued in options is around $ 90 for a bullish consensus and $ 20 bearish:
Small pressures and options strikes
At the time of writing, the highest quasi-dated option strike is 65. As the action increases, higher strikes will likely be added (in fact, strikes are being added today. up to 100), but there is often a lag for short. gamma to be restored. The term “gamma squeeze” has been used frequently in recent weeks, especially when it comes to memes stocks. In very simple terms, this relates to options market makers who perpetuate the upward momentum of a price swing by having to buy underlying stocks to hedge their exposure to put options. It follows therefore that when the ceiling is reached in terms of option strikes, this gamma compression can (at least temporarily) be reduced.
Also, without new out-of-the-money call strikes being available, buying direct calls to trade a bullish view on a stock like TLRY can involve high capital outlays and high breakeven points.
We will then see how option spreads could be used to reduce capital expenditure and potentially improve the probability of profits (compared to buying a call or put purely).
Please note that the referenced actions and / or trading strategies are for informational and educational purposes only and should not be construed as recommendations in any way. The strategies described are just a few of the many potential ways to use the options to express a particular point of view.. All prices are approximate at the time of writing.
Call spreads vs direct calls in high-end stocks
Currently, the TLRY 19 March 65 Appeal trading at around $ 20, risking $ 2,000 to buy 1 contract and involving a breakeven point of approx. $ 85 in the underlying stock (at expiration).
Knowing that the options market evaluates a movement of more than 60% until March, and that strike 65 is currently the highest strike on record, we will now look at an example of a bullish strike TLRY Mar 19 + 55 / -65 Debit Call Gap (simultaneously buy a 55 Call while selling the 65 Call). At the time of writing this is trading at around $ 3.00, risking $ 300 to buy 1 buy spread and implying a breakeven point of approx. $ 58 in the underlying stock (at expiration).
So by using a Call Spread, we lowered the breakeven point and the risk premium, in exchange for a cap on upside potential if the stock moved well beyond the upper strike.
On the chart below, note the breakeven point of this strategy, just a few dollars more than the current stock level, via AI Options:
Also, as can be seen with the two spread strikes, this strategy is trading below $ 3 while the 65 call is around $ 21.00 outright:
It is important to note that the options market is pricing an equally large expected move to the downside. Indeed, using the same methodology, Debit Put Spreads can be applied in the same way to express bearish movement. Options AI does not recommend trading TLRY shares and has no opinion on the future movement of a share’s price.
Summary
Keep in mind that the above items are just examples of the many ways a trader can express an opinion using options. They are based on where the stock is trading at the time of writing and are intended only to demonstrate how the expected move can help provide actionable information to consider before making a trade – in particular in an uncertain event – and how it could be used for more informed strike selection. Learn / Options AI has a few free tools, including a earnings calendar with expected moves, as well as information on expected moves and spread trading. The concepts presented in Tilray can be applied to any stock and are simply used here for illustrative purposes.
© 2020 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
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