With cannabis stocks in the news this week, we’ll reveal what the options market is expecting in terms of upcoming stock moves and look at 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 might be used in a high-premium environment to reduce capital outlay – whatever your trading view.
Overview and Expected Moves
First, a comparison of some of the expected moves 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 Options AI Calculator
With Tilray (TLRY) trading about $55, the options market is pricing an expected move for the month of over 60% in either direction. (note – the company is set to report earnings the first week of March). The move being priced in options corresponds to about $90 for a bullish consensus and $20 bearish:
Short Squeezes and Option Strikes
At the time of writing, the highest near-dated option strike is 65. As the stock moves higher, 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 re-established. The term “gamma squeeze” has been used frequently in the last few weeks, particularly in relation to the meme stocks. In very simple terms it relates to option market makers perpetuating the upward momentum of a price swing by having to buy underlying stock to hedge their short option exposure. It follows therefore, that when the ceiling is hit in terms of option strikes, this gamma squeeze can (at least temporarily) be reduced.
In addition, without further out-the-money call strikes being available, buying outright calls to trade a bullish view in a stock like TLRY can be involve high capital outlays and mean high break-evens.
So, next we will look at how option spreads might be used to reduce capital outlay and potentially improve probability of profits (versus buying outright calls or puts).
Please note, any stocks and/or trading strategies referenced are for informational and educational purposes only and should in no way be construed as recommendations. The strategies depicted represent just a few of the many potential ways that options might be used to express any particular view. All prices are approximate at the time of writing.
Call Spreads vs Outright Calls in High Premium Stocks
Currently, the TLRY March 19th 65 Call trading at approximately $20, risking $2,000 to buy 1 contract and implying a breakeven of approx. $85 in the underlying stock (at expiry).
Knowing that the options market is pricing a move of over 60% out to March, and that the 65 strike is currently the highest strike listed, we will now look at an example of a bullish TLRY March 19 +55/-65 Debit Call Spread (simultaneously buying a 55 Call while selling the 65 Call). At the time of writing, this was trading at approximately $3.00, risking $300 to buy 1 call spread and implying a breakeven of approx. $58 in the underlying stock (at expiry).
So, in using a Call Spread, we have lowered the breakeven and premium at risk, in return for capping potential upside should the stock move far beyond the upper strike.
On the chart below, note the breakeven on this strategy, just a few dollars higher than the current stock level, via Options AI:
Additionally, as one can see with the spread’s two strikes, this strategy trades under $3 while the 65 call is about $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 a similar way to express a bearish move. Options AI does not recommend trading TLRY stock and has no opinion on the future price movement of any stock.
Summary
Remember, the above are just examples of the many ways a trader might express a view using options. They are based on where the stock is trading at the time of writing and are intended solely to demonstrate how the expected move can help provide actionable insight to consider before making any trade – particularly into an uncertain event – and how it might be used for more informed strike selection. Learn / Options AI has a couple of free tools, including an earnings calendar with expected moves, as well as education on expected moves and spread trading. The concepts shown in Tilray can apply to any stock and are simply used here for illustrative purposes.
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