Canadian Medical Cannabis Supplier Tilray (NASDAQ 🙂 announced financial results for FY20 on February 17. After the release, TLRY shares were volatile and came under pressure.
We recently discussed in detail how investors might consider writing covered calls. Readers who are new to options may want to revisit that article before reading this post.
Today we are going to look at the use of an options strategy with Tilray shares. This piece should help increase the reader's understanding of options. For more experienced investors, it likely offers ideas for future trades.
Tilray
Current price: $ 23.55
52 Week Range: $ 2.43 – $ 67.00
Price change over 1 year: Up about 19.6%
Tilray recently made headlines after announcing on December 16 that it will merge with another cannabis company, Aphria (NASDAQ 🙂 (TSX :).
The combined entity will become the largest cannabis company on a pro forma revenue basis. When the trade is completed, possibly in the second quarter of 2021, the combined company will trade on the NASDAQ under the ticker symbol TLRY.
Following the news of the proposed merger, TLRY stock reached a 52-week high of $ 67, now hovering around $ 23.55.
According to the latest financial figures, total sales have increased to $ 56.6 million, an increase of 20.5% year-over-year (year-on-year). The company divides income into two main segments: cannabis (+ 46%) and hemp (+ 18%).
The cannabis segment further consists of:
International Medical (+ 191%);
Canadian use by adults (+ 49%);
Canadian medical (26%).
In the fourth quarter, the net loss was $ 3 million, or a loss of 2 cents per share. A year ago, the net loss was $ 219.8 million, or $ 2.14 per share. Cash and cash equivalents at the end of the quarter were $ 189.7 million.
Meanwhile, Reddit members are also paying more attention to TLRY shares. Investing.com readers would well remember how recent moves by both Reddit merchants and private investors have affected GameStop (NYSE 🙂 and AMC Entertainment (NYSE 🙂 stock prices.
Given the increased volatility in TLRY shares and the potential for further profit taking, a covered call may be a suitable strategy for some investors, especially those who may want to protect some of their recent gains without selling their Tilray holdings .
Covered Calls on TLRY Shares
For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date sometime in the future.
As we write this, Tilray stock is trading at $ 23.55. A stock option contract on TLRY (or any other stock) is the option to buy (or sell) 100 shares.
Investors who believe that more short-term profit could be taken soon, could use a somewhat in-the-money (ITM) covered call. A call option is ITM if the market price (here $ 23.55) is higher than the strike price.
The investor would thus buy (or already own) 100 shares of Tilray for $ 23.55 and simultaneously sell a TLRY April 16, 2021, $ 22-strike call option. This option is currently being offered at a price (or premium) of $ 6.13.
A buyer of an option would be required to pay $ 6.13 x 100 (or $ 613) in premium to the seller of the option. This call option will stop trading on Friday April 16, 2021.
The $ 22 strike offers more downside protection than a call for money (ATM) or out of pocket (OTM).
Assuming a trader entered this covered call trade at $ 23.55, the maximum return at maturity would be $ 458, i.e. ($ 6.13 – ($ 23.55- $ 22.00 )) x 100, excluding trade commissions and fees.
] Risk / Reward Profile for Uncontrolled Covered Call
The maximum profit from an ITM covered call is equal to the extrinsic value of the short call option.
The intrinsic value would be the tangible value of the option if it were exercised now. Thus, the intrinsic value of our TLRY call option is ($ 23.55- $ 22.00) X 100, or $ 155.
Extrinsic value is the difference between the market price of an option (or its premium) and its intrinsic price. In this case, the extrinsic value would be $ 458, i.e. ($ 613- $ 155). Extrinsic value is also called time value.
The trader realizes this $ 458 profit as long as the price of TLRY stock at maturity remains above the strike price of the call option (i.e. $ 22.00).
At maturity, this transaction would break even at a Tilray stock price of $ 17.42 (i.e., $ 22- $ 4.58), excluding trading commissions and fees.
Another way to think of this breakeven price is to subtract the call option premium ($ 6.13) from the underlying TLRY stock price when we initiated the covered call (i.e. $ 23.55).
On April 16, if the TLRY stock closes below $ 17.42, the transaction would start to lose money within this covered call setup. By selling this covered call, the investor thus has some protection against a possible fall in the underlying shares. In theory, the price of a stock could drop to $ 0.
What if Tilray Stock Hits a New Record?
As we have noted in previous articles, such a covered call would increase the upside profit potential. The risk of not fully participating in the potential appreciation of the TLRY stock would not appeal to everyone. However, within their risk / return profile, others may find that acceptable in exchange for the premium received.
For example, if Tilray stock hit a new record and close at $ 67 on April 16, the trader's maximum return would still be $ 458. In that case, the option would be deep ITM and likely exercised. There may also be brokerage fees if the stock is called away.
As part of the exit strategy, the trader could also consider rolling this deep ITM call option. In that case, the trader would buy back the $ 22 call before it expires on April 16. Depending on his / her opinion and objectives with regard to the underlying TLRY stock, he / she might consider starting a different covered call position. In other words, the trader could roll out to a May 21 maturity call with an appropriate strike.
Bottom Line
The exact market timing at which TLRY shares could stop falling or rising again is difficult, even for professional traders. But options strategies provide tools that can help an investor prepare for sideways moves or even stock price declines.
There are many angles involved in using different options for hedging or speculative purposes. Interested readers might consider investing the time and effort to further educate themselves.
