Daily Archives: November 2, 2018

Pot Stocks

3 Pot Stocks to Consider on the Dip

Source: Shutterstock

It took pot stocks just a few weeks in August and September to become the hottest investments on Wall Street. Likewise, it has taken just a few weeks in October to make them some of the coldest investments.

In August and September, pot stocks went crazy. Almost all of them rallied by more than 50%. Some doubled. Some tripled. One rose by more 1,000%. The fundamental backdrop was that pot stocks were gearing up for their biggest catalyst yet — the legalization of cannabis in Canada on Oct. 17. Everyone wanted exposure to weed prior to that catalyst.

But, as was largely expected, the legalization of weed throughout Canada became a “sell the news” event. It has been a bumpy roll-out characterized by supply shortages and consumers turning to the black market. Pot stocks, which were priced for a perfect roll out, have dropped into bear market territory as the roll out has been far from perfect.

Indeed, most pot stocks are well into bear market territory now. As of this writing, most widely followed pot stocks are down more than 30% from recent highs.

But, the long-term growth narrative remains positive. Cannabis is becoming increasingly legal on a worldwide basis, and consumer trends indicate that once legal, recreational pot could be as widely consumed as alcoholic beverages. Throw in the medical applications of cannabis, and you are talking about a market that promises to be huge.

So, is it time to buy the dip in pot stocks?

Maybe. Because the momentum is gone and the focus is back on fundamentals, you should only buy into pot stocks when the valuation makes sense. For some of these names, the valuation is starting to make sense. For others, not so much.

With that in mind, here’s a list of three pot stocks investors should be watching during this selloff.

Canopy Growth (CGC)

pot stocks Canopy Growth (CGC)

Source: Shutterstock

Time and time again, I’ve claimed the best investment in the cannabis sector is Canopy Growth(NYSE:CGC).

Due to its early market leadership, distinguished track record, biggest production capacity, widest portfolio of brands and billion dollar partnership with alcoholic beverage giant Constellation Brands (NYSE:STZ), CGC stock is head-and-shoulders above other pot stocks when it comes to investment attractiveness. But, that didn’t make CGC stock immune to broad cannabis sector weakness. As I warned in mid-October, all pot stocks — CGC included — are due for weakness in the near term.

Fast forward a week. CGC stock has dropped more than 30% since then. Time to buy the dip?

I think so. There may be more weakness ahead as the Canadian cannabis roll out continues to be bumpy. But, CGC stock is now nearing levels it was at just after the STZ investment. Those levels seem fundamentally supported by STZ’s $4 billion investment, and as such, I don’t see the market sending CGC stock below the low $30’s any time soon.

Meanwhile, reasonably optimistic growth assumptions point to healthy long-term upside for CGC stock.

As such, now looks like a good time to start gradually buying the dip in CGC stock.

Tilray (TLRY)

pot stocks Tilray (TLRY)

Source: Shutterstock

Just as I’ve reiterated time and time again that Canopy Growth was the best investment in the cannabis sector, I have also warned time and time again that Tilray (NSDSAQ:TLRY) is the most overvalued.

Despite having lower sales than CGC, a less distinguished track record, smaller production capacity, a more narrow portfolio of brands and no billion dollar partnership, TLRY stock has been rewarded in the stock market with a bigger valuation than CGC stock. This discrepancy doesn’t make sense, and it’s why TLRY stock fell the hardest during this recent correction. Over the past few weeks, TLRY stock is down more than 35%. It’s also more than 50% off September highs.

Unfortunately, this valuation disconnect still hasn’t fixed itself. As of this writing, Canopy has a market cap of $7.5 billion. Tilray has a market cap of over $9 billion. That relative valuation disconnect shouldn’t exist, and so long as it does, Tilray stock will struggle.

As such, I don’t think this recent dip in TLRY is worth buying. The company has healthy long-term growth drivers. But, at a $9 billion-plus valuation with smaller market share than peers, all that growth is already priced in, and then some. With momentum now favoring the bears, investors can afford to wait for TLRY stock to come down further before speculating on long-term upside.

Cronos (CRON)

pot stocks Cronos (CRON)

Source: Shutterstock

Next to Canopy, my second-favorite pot stock is Cronos (NASDAQ:CRON). But, even though I’ve favored this name over peers, I also warned in mid-October that buying then was dangerous.

Since then, CRON stock has come down about 30% to levels not seen since shortly after the big Constellation Brands investment into Canopy. That is a big wipe-out in a short amount of time. And, it has left CRON stock undervalued.

Cronos has a market cap of just $1.3 billion, versus $5 billion-plus market caps at Tilray and Canopy. A big reason for the lower valuation is lower production capacity. CRON has planned production capacity of roughly 1.2 million square feet, versus 3.8 million square feet for TLRY and 5.6 million for CGC.

But, each square foot of Cronos production capacity is being undervalued relative to Tilray and Canopy’s. The market cap per square foot of planned production is about $2,350 at TLRY and $1,350 at CGC. At CRON, it is just $1,100.

That doesn’t make much sense, especially considering Cronos is projecting yield of 110,000 kilograms of cannabis on those 1.2 million square feet. That equates to almost 100 grams of weed per square foot, which is a very attractive yield.

As such, once pot stocks stabilize from recent volatility, CRON stock could be a buy. I still think CGC stock is the best in class, but CRON stock offers relative valuation upside that is quite attractive.

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Options

Volatility Will Normalize and Here’s How To Profit When It Happens

Market volatility has essentially become a mainstream metric in the investment realm – especially for anyone who does any short-term trading. Most traders are now aware of what the VIX is and how a higher level in the volatility index usually means more uncertainty in the market.

While investors and traders may not be able to explain what the VIX actually is (the implied volatility of S&P 500 options), they do realize it’s important to keep an eye on market volatility. Generally speaking, higher volatility levels can precede a selloff in stocks. Conversely, a falling VIX may give us an “all clear” signal during more tumultuous times.

Options traders should be more intimately familiar with the concept of volatility. Since volatility is the key component in the calculation of options prices, it is vital for active options traders to have at a least a basic understanding of how it works.

One thing I’ve noticed while speaking at the MoneyShow and Traders Expo investment conferences is that traders appear to have a growing interest and understanding of volatility. It’s definitely an encouraging trend. The more options traders (and stock traders for that matter) understand about volatility and how it impacts the market, the better chance they have of avoiding catastrophic losses.

But here’s the thing…

Volatility doesn’t just tell you when to get out of your long positions. It can also be a great signal for when to get back in the stock market. For example, if the VIX is headed lower after a turbulent period in stocks, it could mean that investors aren’t hedging as much because the feel the uncertainty is coming to an end.

When volatility spikes, I like to look at the options action on volatility ETPs (exchange traded products) such as iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX). VXX is a widely popular ETN used to trade short-term volatility. VXX will go down when front-month VIX futures (the VIX itself is not tradable) move down. Thus, it’s an easy way to bet on volatility going down (without having to trade futures).

What’s more, bearish options action in VXX could be a sign that traders expect volatility to come down in the near future. For instance, I recently came across a bear call spread – a call spread sold for a credit – which predicts that VXX isn’t going to keep climbing prior to mid-November.

More specifically, with VXX right around $40, a trader sold 6,500 November 16th 45-60 call spreads for $1.21 credit per spread. That means the trader sold the 45 call and bought the 60 call at the same time. The strategy reaches max profit as long as VXX is under $45 by expiration.

If VXX stays below $45, the trader could pocket $786,000 dollars. However above $46.21 (the breakeven point) the call spread seller could lose $650,000 per dollar higher – all the way to $60. In other words, this could be a very risky strategy.

The strategist who placed this trade clearly believes VXX isn’t going much higher in the next two weeks and more likely, is headed lower. Keep in mind, once mid-term elections and the FOMC meeting are over with in the first full week of November, there may not be much action heading into the Thanksgiving holiday. That is to say, I think this trade makes a lot of sense.

Nevertheless, selling potentially risky call spreads is not a strategy I recommend for most options traders. In fact, I believe it’s far easier to simply buy a put spread on VXX instead.

If you think volatility is going to drop after the mid-term elections/FOMC meeting, buying the 37-34 put spread (buying the 37 put, selling the 34 put) can be done for about $1.20 with VXX at $39. That’s a reasonable price to pay given how quickly volatility can move (up or down). Moreover, the trade can max out at 150% gains if VXX drops to $34 or below by expiration.

 

Market Preview

Market Preview: Markets Rise and Fall on Trade Comments

Markets traded Friday as if the White House and its inhabitants were engaged in the children’s game of telephone. Pre-market reports from Bloomberg that President Trump had directed White House staff to draw up a trade agreement with China saw DJIA futures sprint over 300 points to the plus side. After a CNBC reporter played part of his interview with White House Economic Advisor Larry Kudlow, stating a deal was not in the works but could happen at some point, futures fell quickly to up only 200 points. The release of the jobless number, which came in at a red hot 250,000, buoyed the futures market until investors realized the numbers gave the Fed more ammo to raise rates. Markets opened positive and then sold off as Apple (AAPL) earnings weighed especially heavy on tech. But, late in the afternoon markets rallied to pare losses as President Trump said a trade deal with China was closer. Investors can take one lesson from market movements on the first Friday of November, volatility appears to be here to stay for the foreseeable future.

Monday analysts will parse earnings from Occidental Petroleum (OXY), Marriott (MAR) and Sysco (SYY). Oil continued to slide Friday, but an Exxon Mobil (XOM) earnings beat kept the stock in positive territory. Investors will be anxious to see whether Occidental can match the good news out of Exxon and halt the damage in the stock inflicted over the past few weeks. Marriott beat and raised earnings estimates for the year last quarter, but currency headwinds may be taking a toll on the company as 2018 has marched on. Analysts will be looking for continued strong growth in the Starwood brand, which Marriott acquired in 2016.

In addition to earnings, economic numbers released on Monday will include PMI services data and the ISM non-manufacturing index. The ISM index came in at 61.6 for September. Any number above 50 indicates growth in the index components which include services, construction, and mining among others. Tuesday investors will see the release of weekly Redbook retail numbers as well as the Labor Department’s job openings data. Wednesday begins a two day Federal Open Market Committee meeting, but no action on rates is expected from the Fed until December. Even so, the Fed statement to be released Thursday afternoon may rattle markets. Wednesday morning mortgage application numbers will be released followed by jobless claims on Thursday. Friday we’ll digest the Producer Price Index for October, which is expected to rise .2%. Also released Friday will be consumer sentiment and wholesale trade numbers.

As we are in the heart of earnings season, several large names report next week. Tuesday Eli Lilly (LLY) and CVS Health Corp. (CVS) are scheduled to report. Wednesday Qualcomm (QCOM), Twenty-First Century Fox (FOXA) and Prudential Financial (PRU) will all release earnings. Qualcomm was recently downgraded by BofA citing a lack of opportunity to cut costs and softening smartphone demand. Disney (DIS), Astrazeneca (AZN) and Activision Blizzard (ATVI) release numbers on Thursday. Call of Duty 4, recently released by Activision, has broken sales records for the franchise, but the stock was not spared in the recent market selloff. GNC Holdings (GNC) and Potbelly (PBPB) close out the week with earnings on Friday.    

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