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The Best Way to Capitalize on the Cannabis Bump

The cannabis sector has had a strong start to 2024, and progress on a few key catalysts could drive the sector even higher. Here are two low-cost options trades if you’re bullish on marijuana.

Sparklers and Champagne Glasses

Even despite recent weakness, cannabis stocks, as measured by the New Cannabis Ventures Index, have been performing well this year, up 20% in 2024 alone.

Of course, as subscribers to Cabot Cannabis Investor know, Chief Analyst Michael Brush has been beating those returns in his own portfolio and giving his subscribers an edge. But even if you’re a passive investor in something like the Amplify Alternative Harvest ETF (MJ), you’ve enjoyed a solid run-up so far this year.

If you’re not currently invested in marijuana stocks but are optimistic on the possibility of positive rescheduling news in the early summer or legalization (depending on the outcome of the November elections) in the fall, and want to add exposure, there are a few ways to play it.

Personally, I’m partial to using options on marijuana ETFs in order to reduce my capital outlay.

Simply buying ETFs like MJ or the AdvisorShares Pure U.S. Cannabis ETF (MSOS) is a perfectly good way to add broad exposure to the sector. But given that the cannabis index is down 90% in the last five years, using options can give you similar upside exposure at a lower price.

The downside of using options is that they’ve got a shelf life: their expiration date. So you should have a clear catalyst (and timeline) in mind.

So, what are those potential catalysts?

For one, this recent rally has been sparked by comments from Vice President Kamala Harris about the absurdity of classifying marijuana alongside far more dangerous drugs. Those comments, coupled with meaningful action on rescheduling by the Department of Health and Human Services (HHS), raise the possibility that we could see rescheduling in the current administration.

On top of that, there are significant polling and cultural trends that point to growing acceptance of marijuana on both sides of the aisle, something that Cabot Cannabis Investor keeps close tabs on. As frustrating as it may be for apolitical investors, legal weed (and removing the hurdles weed companies face while doing business) is ultimately a political question.

So, with meaningful catalysts in mind (and acknowledging the long-term sector returns), let’s talk about a few ways to add exposure to the marijuana sector without diving in head-first.

As I mentioned above, one simple way to add cannabis stocks to your portfolio is through an ETF like the aforementioned MJ or Michael’s preferred marijuana ETF, MSOS.

Both funds have ample trading volume and offer broad exposure to the sector while mitigating the one-off risks of individual pot stocks.

The funds also have reasonable expense ratios of around three-quarters of a percent, which is higher than many broad-based passive funds, but not abnormal for a specialty fund.

Either one is a solid option to add marijuana to your portfolio, especially if you’re looking at an intermediate- or long-term position.

For short-term or momentum investors, there are lower-cost ways to add comparable portfolio exposure to take advantage of the recent rally using options.

2 Cannabis Options Trades

To take advantage of the liquidity and diversification mentioned above, both options trades will use MSOS as the underlying ETF.

The first we’ll look at is a relatively short-term call, the May 17, 2024, 9 call on MSOS.

As of the time of writing, MSOS is trading at 9.52 and these calls are trading for about $1.45 ($145 per contract).

The reason for this call and expiration is twofold. One, the 9 strike has ample open interest, which translates to higher volume, more liquidity, and generally lower bid-ask spreads.

Two, if the current administration wants to reschedule before election day, the DEA needs to propose rules before early summer.

The contract is trading with about $0.50 of intrinsic value, meaning that you’d pay ~$0.95 of time and volatility premium. This puts the breakeven for MSOS at 10.45, about 10% above where it’s currently trading. But after that, you’d see dollar-for-dollar gains in the contract. And your capital commitment is only 15% of what you’d spend to buy the ETF outright.

A quick note on that: Yes, two-thirds of your outlay is being spent just for the privilege of holding the contract (time and volatility premium) and you’re only buying a small amount of actual value.

However, if we don’t get rescheduling news, a 10-15% decline in the underlying ETF would not be out of character (we’ve already seen a 20% decline once this year). Put another way, your max loss with the option contract (if it expires worthless) isn’t much different than what one might anticipate taking as a loss in the event of bad news for the sector.

If you’re looking for a longer runway (and want to get past election day) you could consider the November 15, 2024, 10 calls.

These calls have lower open interest than the May calls but are the most heavily traded strike in that expiration cycle.

They’re currently trading for about $2.55 and are a point higher than our May calls, so you’re paying a higher premium to buy an additional six months of life on your contract.

Your breakeven on these calls would be 12.55 for MSOS, which is 32% higher than it’s trading today.

Like the shorter-dated calls, you’d gain dollar-for-dollar appreciation above your breakeven, but the lion’s share of the contract price is just buying time.

Bringing politics back into the equation (unfortunately), this contract offers potential upside should rescheduling efforts fail to gain ground in the summer months but look more like a possibility after the elections.

Of course, if rescheduling falls apart over the summer, MSOS is likely to decline significantly, which would offer a much more attractive entry price in the intervening months before the election.

For a short-term play, I like the May calls (or you could look at June, depending on when you’re reading this). If you’re long-term bullish and think that not only is rescheduling on the table now but that full-blown legalization could be on the table after the elections, I think you can make a case for the November calls as well.

That said, the November calls are a little rich for my blood (premium-wise) and you’d probably get more bang for your buck buying a combination of the underlying ETF for long-term exposure and the May calls for the short-term momentum.

Brad Simmerman is the Editor of Cabot Wealth Daily, the award-winning free daily advisory.