Investors seem to be the only people in the world who have trouble getting high on marijuana.
The stocks of companies focused on cannabis—which has been marketed to investors as holding incredible medical promise and as an alternative to alcohol—have largely proven to be bad investments. Yet a simple portfolio management trick can help long-term investors recast their fallen stocks at radically better prices. The timing is good.
The sector proxy, the ETFMG Alternative Harvest exchange-traded fund (ticker: MJ), is down 22% this year and dancing around a record low. Many of the top marijuana stocks—companies that generate the type of passion also seen around Bitcoin—are down even more sharply. Investors have lost loads of money.
We recently advised investors to position for lower lows in the sector. We reasoned that theme investments wouldn’t likely fare so well after the failed stock offering of WeWork’s parent company, a spectacular event that seems to represent a sea change in investor sentiment toward stocks valued on what may happen in the future rather than on past financial results.
While we haven’t changed that dour view, we recognize that many investors view marijuana stocks as long-term investments, even if the stocks are often wounded and trading in speculative wrappers. For those willing to wait for the weed sector to live up to its potential, it is possible to at least reset the cost basis of thus far failed investments.
Consider Canopy Growth (CGC). The stock is down 25% this year, but it arguably trades with a quasi-halo effect because Constellation Brands (STZ), a major beverage company, invested about $4 billion in the company in August 2018, when the stock was around $32.
Many investors likely followed Constellation Brands into the stock in anticipation that the company would benefit from the support of a major corporation. Unfortunately, not much good has happened. Constellation stock has since lost about 38% of its value. During the past 52 weeks, it has ranged from $17.89 to $52.74.
To buy Canopy Growth stock at today’s lower price and reset one’s cost basis, long-term believers could use a technique called the “double-up strategy.”
This entails buying the same number of shares as your existing position at the current price and then selling the existing position in no less than 31 days. If you sell the old position before the holding period has passed, you will violate the so-called wash-sale rule, and the Internal Revenue Service won’t let you reset the cost basis.
Rather than using stock, as is the traditional method, it is better to use options, given the unusual risks around the stock and sector. Options allow investors to control the same amount of stock for less money—and thus less risk. Should cannabis companies prosper, the percentage returns with call options will be much higher than with straight stock.
“The perpetual goal of all investors is to maximize gains and minimize losses. Sometimes, a well-placed options contract is the best way to do just that,” says Michael Schwartz, Oppenheimer’s chief options strategist.
When Canopy Growth’s stock was at $20.10, investors could buy the January $22.50 call that expires in 2021 for $3.94. (Calls increase in value when the underlying security price increases.)
If Canopy Growth is at $30 at expiration, the call would be worth $7.50. If the stock is below the stock price at expiration, the trade fails and investors lose the money they spent on the call—and would no longer have exposure to the stock.
While there are risks in every investment, the double-up strategy helps to minimize the amount of money at risk, which is always useful, especially when committing more money to troubled companies that one hopes will fly higher.
The last day to make this move is Nov. 29. After that, there isn’t enough time left in the year to take the loss and avoid the wash-sale rule.
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