Aurora Cannabis (ACB) stock had a tough 2019. It lost about 59% of its value in the year. Considering the company’s 52-week range, we can conclude that its stock is volatile and risky. With that said, I want to present to you with a strategy that allows for entry into the stock with minimal downside risk and solid upside potential. Without further ado, let’s take a look at the specifics.
My number-one cannabis stock pick right now
Aurora appears to be a risky bet for a direct stock purchase due to its high volatility and correlation with the market and other cannabis companies. I think it looks more attractive considering how traders and investors can use the options market to benefit from its possible movements with lower risk.
So, let’s take a look at the ACB options chain. Currently, Aurora has options expiring in January, March, and June. This allows us to create an options structure that generates cash, garnering a solid margin of safety in a very volatile stock (through put selling) while also setting us up to receive potential upside through call buying. Going forward, we can realize this by combining a put and a call spread, with the put expiring at an earlier date than the call spread.
Options traders and Aurora Cannabis stock
As of market close on January 3, the applicable options were trading at the following bid/asks:
- March 20, 2 put has a bid/ask of $0.39 and $0.41.
- June 19, 2 call has a bid/ask of $0.47 and $0.50.
- June 19, 3 call has a bid/ask of $0.23 and $0.24.
To be more precise, I would propose selling a March put with a strike price of $2 combined with a December call spread for a strike of $2/3. At the current mid-price, an investor or trader is able to sell the March put option with a strike price of $2 at approximately $0.40 per contract if we’re not considering costs and commissions.
It could also be pooled with the purchase of a March put option with a strike price of $1 for a price of approximately $0.06, cutting the downside risk to $1.00 per option if Aurora Cannabis stock falls below $1. However, I would consider such a movement highly unlikely. If we look at Aurora Cannabis’s technicals chart, we can see that the stock recently bottomed at $1.88 and pulled back. I’d set the floor for an ACB price per share at around $1.5. Therefore, the purchase of a $1 put isn’t justified.
Another way to benefit from Aurora Cannabis stock
Contemporaneously, investors can position themselves to benefit from the stock’s expected volatility and recovery by purchasing a June 19 call spread. The cost per option of a call spread by buying a call and selling the next sequential call would be $0.25. I think investors can position themselves for substantial upside while limiting downside by utilizing this structure, which allows for the combination of different dates for put and call spread expiration. For example, if an investor decides to sell two put contracts with a $2 strike expiring in March for a premium of $80, he or she can purchase two $2/3 bull call spreads.
Looking at the June 19 call and put options with a strike of $2.00, we can calculate the expected price move using the mid-prices of the given options. Note that the options strike price is closest to ACB’s closing price of $2.00 as of January 3. With that, let’s look at the calculations:
0.485 (2.00 put) + 0.56 (2.00 call) = 1.045/2.00 = 52.25%
What the market expects for ACB
It’s obvious that the market expects a move of around 52% for ACB by the June 19 expiration date. This estimation means that ACB could move up to $3.04 or down to $0.96 by June. With all things considered, our aforementioned call spread structure could easily profit from such upside movement, in which our June 19 call would expire worthless, allowing us to increase our gain.
For our given structure, the capital at risk is $200 for each put option sold if Aurora falls to $0, while the potential upside is capped at $100 for each call spread bought. However, considering the capital at risk, in the worst-case scenario, I find it unlikely Aurora Cannabis stock would drop below the $1.50 price level.
Want to read more recommendations based on options structures and options market analysis? Check out Why You Should Buy Aurora Cannabis Stock in 2020, Apple: An Options Strategy if You Expect a Recession, and NIO and AAPL, Two Stocks with Unusual Options Activity.