I’ve been debating getting into “pot stocks” for a long time and was happy I waited since they tanked from their 2019 highs. Rather than work through the weeds of each individual stock and take the risk of not diversifying, I’ve been following the ETF, MJ. Officially, MJ tracks an index of “Pharmaceuticals, Biotechnology and Life Sciences group of industries”. In reality, the top holdings are marijuana based companies. Its top three holdings include APHA, TLRY, and WEED. Those three stocks alone equal more than 30% of the holdings.
After the November election, this whole sector got a boost on the belief that President Biden would be more progressive than previous administrations with decriminalizing marijuana. Then, after the Georgia runoffs, when we saw the democrats take control of the senate, the sector moved higher again on stronger conviction. Since the election results don’t guarantee a change in the laws and definitely not necessarily a quick change, these lofty hopes for big earnings could go up in smoke before they flower.
On February 1, Senators Cory Booker (D-NJ), Ron Wyden (D-OR) and Chuck Schumer (D-NY) issued a joint statement regarding comprehensive cannabis reform legislation and pot stocks took off. I was slow to react with my trade due to my belief that prices would be blunted by the reality of how slow progress will be, but that just meant I missed out on the easy growth from these first waves of excitement. I expect reasonable prices still need to be hashed out and instead of buying into MJ while it was up more than triple its price from October prices, I opted to sell out of the money puts to get some exposure with a lower risk.
While MJ was trading at $26.51, I sold two MJ April $20 naked puts for $1.75 each and received $350.24 after receiving a $0.24 commission rebate. (Some exchanges pay to have opening option trades versus just trading what’s already on the exchange.) MJ peaked at $34.58 yesterday morning before it hit a stoned wall when the reddit buzz started to wear off. I expect the ETF to move back into the $18-20 range before reversing eventually and breaking above $35 and that’s why I set my strike so low.
The cool perk to trading with options is that if MJ stagnates in the mid-20s or moves higher, I still make my planned profit of 9.55%, which is 53.37% annualized and MJ can fall another 31.13% before I lose a dime. Even with a price decline of 24.56%, I’ll still make my full profit.
I only sold two puts because I realize the risk is still relatively high since it wasn’t long ago that MJ was close to $10 and I wanted to keep my losses edible without creating heartburn if my price targets are way off. It’s absolutely possible that MJ could trade back into the mid-teens before these April puts expire. Since my cost per share if assigned these put options would be $18.25, I don’t expect a loss of more than $650. (That’s my cost of $18.25 minus a $15 target times my 200 shares.) If MJ drops as low as $15, I’ll have the choice of selling new puts at a much lower strike to dollar cost average lower and also selling out of the money covered calls to cover my paper losses. I can roll my options into higher or lower strikes as needed.
I’m looking at MJ as a long-term position if assigned. I’ll add to it on price dips and might take some profits short-term if we get more price spikes like this week. At some point, the federal laws will catch up to the many states that have already legalized marijuana and the companies within this ETF that survive will do very well. We just have to let the process shake out on its own timeline.