In Case Canopy Growth Shares Go Up In Smoke Again

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About: Canopy Growth Corporation (CGC)
by: David Pinsen
Summary

Canopy Growth's shares have been on a roller coaster ride since I wrote about hedging them back in October.

After losing about a third of their value last fall, they've since climbed back to price levels we saw in early October.

In the event they suffer another swoon post-earnings, I present an updated hedge for the shares. I also note the possible significance of a difference between the two hedges.

Canopy Growth's TSX Launch (photo via HuffPost).

In Case Canopy Growth Doesn't Stay High

In October, after Canopy Growth's (CGC) shares had climbed 376% over the previous year, I presented a way longs could limit their risk.

Chart

A few months later, after Canopy's shares had lost a third of their value, I showed how the October hedge limited the damage for Canopy Growth longs.

Chart

Since then, Canopy Growth's shares have climbed back to their early October levels.

Chart Data by YCharts

The last leg of Canopy Growth's swoon last fall occurred after the company's Q2 miss. In the event the company breaks shareholders' hearts on Valentine's Day next week (when it's scheduled to announce its latest earnings), let's look at an updated hedge for CGC.

Keeping Your Canopy Shares From Going Up In Smoke

Ordinarily, when I write articles about how to limit your risk while staying long, I present two hedges: One for investors who are willing to pay for protection and don't want to cap their upside, and another for those who are unwilling to pay, but are willing to cap their upside. Here, as was the case in October, only the second kind of hedge was available.

For both of these examples, I assumed you had 1,000 shares of CGC and were unwilling to risk a decline of more than 20% over the next several months. When scanning for the optimal, or least expensive put options to hedge against that (the uncapped hedge), I got this error message from the Portfolio Armor iPhone app:

No Optimal Puts Available For CGC

The reason I got that error message is because the cost of put protection against a >20% decline had a cost greater than 20% of position value.

However, by capping the upside at 17%, not only was I able to find an optimal collar hedge, but I found one that had a negative net cost:

Optimal Collar Hedge On CGC via Portfolio Armor.

Looking at the cost of the put leg of this hedge, $5,200, or 11.08% of position value (calculated conservatively, using the ask price of the puts), some readers may wonder why those puts wouldn't have worked by themselves as an uncapped hedge. The reason is that, after taking into account the cost of the hedge, your maximum drawdown with those puts would have been more than 20%.

In this collar, though, the $5,200 cost of the puts is more than offset by the income generated by selling the call leg of $5,450, or 11.61% of position value (calculated conservatively, using the bid price of the calls).

So the net cost of this hedge would have been negative, meaning you would have collected a net credit of $250, or 0.53% of position value, assuming you placed both trades at the worst ends of their respective spreads as of Thursday's close.

Wrapping Up

I noted above that an uncapped, optimal put hedge for Canopy Growth was unavailable in early October, as it was unavailable on Thursday. That's one similarity with now, but there's a difference worth noting here when it comes to the optimal collar hedges. In October, in order to get a negative cost collar against a greater-than-20% decline over the next several months, we just had top cap the potential upside at 26%; in February, we have to set that cap at 17%. That suggests options market participants are somewhat less bullish on its prospects over the next several months than they were back in October.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.