No matter where you invest your money, the risk of loss always exists. Medical marijuana, hemp and CBD investment alternatives are new opportunities for mainstream investors, and with anything new comes the unknown. Commodities like crude oil and wheat, or equity sectors like tech, pharmaceutical and transportation, have been around long enough that analysts are familiar with their seasonal tendencies and all of the supply and demand factors that can generally impact them. Analysts are also adept at technical analysis, which only holds merit with an asset that has enough data points that price anomalies can be easily identified. Even with a closely documented history and lots of data, past performance is not necessarily indicative of future results, which is why risk always exist. With the cannabis sector though, there is no real past performance for analysts to research. Not to mention the fact that evolving cultivation practices and changing national laws add unpredictable variables making the sector very volatile, albeit one with strong long-term potential.
One World Pharma (OWP) (OTC:OWPC) is a cannabis producer headquartered in Las Vegas, Nevada, with cultivation facilities in Colombia. Just north of the equator, Colombia’s climate makes it the most ideal region of the world for the year-round growing of cannabis and hemp at the most affordable costs. The infrastructure for exporting cannabis is already well established, since Colombia already has ports and distribution routes setup for the myriad of other goods they export. Colombia is expected to provide the world with a significant amount of its medical marijuana import requirements. Solid socially responsible relationships with the indigenous people of Southern Colombia and an in-process onsite state-of-the-art extraction facilities, has OWP setup as a prime equity investment for any investor interested in diversifying into this new and promising sector.
Risk is the nature of investing capital, which is why investors are always encouraged to use discretionary capital. In order to increase the likelihood of long-term compounding growth, risk management is an essential aspect of investing whether you manage your own portfolio or work with some sort of an advisor. It behooves investors to have a fundamental understanding of risk management strategies, regardless of who is managing their assets. There are many ways an investor can go about managing risk and hedging without necessarily having to sell a potentially valuable asset. Applying risk management to any equity makes sense, including OWPC. One of the great things about One World Pharma’s innovative business model is that you can hedge your current cannabis holdings with an OWPC investment. It’s a completely different model than the traditional branding and product companies. They still cultivate and extract like the others but OWP is a pure-play cannabis company and will provide low cost and high quality ingredients for the product makers including OWPC. At this juncture however, hedging alternatives are limited relative to older more liquid assets. Let’s explore what alternatives do exist so that you as an investor have the best chance of capitalizing on the cannabis sector in these early stages..
To give you some perspective and to ensure there is no confusion, let’s make sure you understand what we mean by hedging in terms of risk management for holding OWPC as a part of your portfolio. Farmers around the world contend with volatility and risk each and every year. Weather patterns, disease and consumer supply and demand factors can dramatically impact prices of their crops. If the price of fuel climbs, farmers can face massive cost spikes that hurt their net return significantly. For these reasons, when warranted, farmers execute short futures positions equivalent to the amount of their physical crop holdings with their local grain elevators to lock in prices for their crops. If the price of corn, soybeans or wheat drops off, the short positions make back the money the farmer would ultimately lose when selling their physical crops. This is classic hedging, but these approaches are not available yet until major exchanges start offering tradable contracts. Conceptually though, an equity investor can apply similar strategies to protect their holdings without losing the asset entirely from their portfolio. Long-term growth may have more to do with minimizing losses as opposed to focusing on winning positions.
Potential Negative Factors Affecting Publicly Held Cannabis Companies
We must first understand factors that can negatively impact a company like One World Pharma. Potential factors that could adversely impact OWPC share prices are as follows:
- Colombian cannabis law regression
- Changes in international cannabis and hemp laws
- Perpetuated stigmas
- General price drops of cannabis globally
- Crop disease
- Economic recessions
- Market Correlation
- Company specific risk
While most commodities do not generally see many law changes very often that meaningfully impact their price, nor is company specific risk much of factor with a commodity’s price, many of the above risks apply to most commodities. An abundance of natural gas came to the market due to more efficient extraction techniques discovered over ten year ago. The glut of supply led to depressed prices of the fuel source for nearly ten years now. An oversupply of corn led to innovative techniques to make ethanol and vodka in the U.S., which caused the price of corn to spike once again. Middle East turmoil results in very volatile prices for petroleum based commodities. Cannabis and hemp must also contend with these same sorts of challenges, plus a slew of others due to its illegality in many countries, stigmas and other factors.
Hedging Alternatives Available Today for OWPC Shareholders
While risk management alternatives are not as abundant for cannabis company stock holders as they might find for other sectors of their portfolio that have been around longer, potential hedges certainly exist. In this section we will review 3 of the top risk management strategies that exist today: Portfolio Diversification; Inverse ETFs; Hedging Put Options.
One of the most basic and fundamental methods of hedging portfolio risk is diversification. While advisors, investors and Wall Street throw the word diversification around regularly, true diversification is very difficult to achieve. In order for a portfolio to be truly diversified, the different tranches of the portfolio must be uncorrelated. In other words, in order for diversification to actually work, the different parts of the portfolio must perform differently. When one tranche is struggling, other tranches must persevere to make up for the loss. A portfolio full of parts that are all performing well simultaneously may look good on the surface. It may feel like all the cylinders are firing at once and the strategy is working well, when in fact this is a dangerous indication of a very correlated portfolio. If the goal is to make money, then if one asset is performing the same as another asset, for all intents and purposes they might as well be the same asset. The unique nature of the cannabis sector makes it potentially advantageous for these very reasons. Companies like OWP may add more diversification to a portfolio due to its unique price movements relative to other sectors.
When a correlated portfolio is the most dangerous is during massive downtrends in the overall market, as seen with the 2008 subprime lending crash where major stock indices like the S&P 500 lost more than 50% of their value. If a portfolio is correlated to the S&P 500 then it is accepting a tremendous amount of risk and if that is what the investor wants, they could save themselves a lot of money and simplify their portfolio just by putting all of their money into an S&P ETF. Generally speaking, that is a bad idea due to the risk of such an investment. If your portfolio were to lose more than 50% of its value, it would take over a 100% return just to get back to breakeven. Hardly any investor can tolerate this sort of risk. Properly weighting your portfolio with bonds, equities and alternative investments to achieve true diversification is one of the most fundamental risk management strategies. You should not invest solely in OWPC equities, just as you should not invest all of your money in any single asset.
ETFs or exchange traded funds are an aggregate of multiple assets all packaged together. They are a means of adding diversification to a portfolio while only needing to manage a single position. An inverse ETF is a fantastic addition to the overall market that allows investors to take advantage of potential downtrends in markets without the expense and risk of holding short positions, which have an unlimited risk in a bull market. Instead of the investor needing to margin a position and potentially pay interest, the fund manager of an inverse ETF accepts those expenses and so the buyer is left with a position that functions much like a traditional equity purchase except is profit potential comes from a downtrending market.
Horizons ETFs is one of the fund managers that has stepped up in the cannabis space creating ETF’s like HMMJ. These ETFs are made up of some of the largest publicly traded cannabis companies in the world currently. Horizon introduced the first cannabis inverse ETF, HMJI, creating an asset that allows investors to potentially make money on a downtrend in the cannabis sector. HMJI is an inverse of the North American Marijuana Index (MOC). For every 1% the MOC declines in a day, HMJI is expected to grow 1%, before fees. As you can see below, since the inception of the HMJI inverse ETF, this has held true as the MOC has been on a decline.
As you might have already guessed, a position in HMJI may be one of the best hedges against your OWPC holdings available today. The ETF is young and needs more liquidity, but that will come with time. You must also execute the position on the Toronto Stock Exchange (TSX). Until OWPC Call and Put options become available, which will come with liquidity, HMJI may be the best choice for hedging your OWPC holdings without having to acquire a short equity holding. If viewed as a risk management strategy, the same factors that are leading to a downtrend in the cannabis sector as a whole, may also lead to a downtrend in the share price of OWPC. In this way, you are cutting losses on any OWPC holdings you have without needing to forfeit holding the asset.
It is important to acknowledge though, that if the cannabis sector is on an uptrend, profits will likely be minimized by an inverse position since it will lose money as the cannabis sector as a whole climbs. Hedging positions should be acquired when there is a genuine concern backed by facts that a decline in the share price is imminent along with the decision that you would like to maintain your holdings of OWPC.
Hedging Put Options
A classic hedge for an equity holding is the purchase of put options. Calls and Puts are equity options and they are 3-dimensional instruments which makes them more challenging to understand in comparison to their underlying asset, the stock itself. Buyers and sellers are the only investors affecting the price of a stock like OWPC. With an option, the investor is more concerned about the value of the option’s premium going up and down, and the underlying stock is just one of the three factors determining the options premium day-to-day. Time and implied volatility are the other 2 factors affecting an option’s premium value.
Options are time wasting, meaning that they have an expiration date and as that date approaches the option’s premium is rushing towards either holding a final definitive value or no value at all. Implied volatility is the effect the buyers and sellers of a particular option are having on the premium value. It is important to note that options are tradable, meaning that an option holder is not obligated to hold the option until expiration, but can trade out of it to either capture a profit or limit a loss.
The Alternative Harvest ETF MJ is the most liquid global cannabis ETF in the world currently. It has the most liquid options as well, which is why we will use it as the example. Take the January 2020 put options on The Alternative Harvest ETF MJ below, they all expire on January 17, 2020. After the close of the market on October 24, 2019, the time of this snapshot, the MJ ETF closed at a share price of $20.45. The highlighted 18 Put is worth about $100 at the close of business on October 24th. If by the expiration, January 17th, MJ is trading at or above $18/share, the option will be worthless. The investor that bought it today would lose the $100 they spent on it. However, if MJ dropped in price between now and January 17 and fell below $18/share, the option would be worth however much MJ was below $18/share, times 100 shares. So, if the stock was trading at $15/share at expiration, the $18 put would be worth $300 and the investor would have made $200 on the position that cost them $100 originally, or a 200% return.
If an investor in MJ (someone that had purchased MJ stock), were to purchase a January 2020 $18 put, that investor would still want the stock to go up and be fine with their option expiring worthless. Their reasoning for buying the put would be that they were worried their stock would fall in price by the January 17th expiration. The purpose of buying the put is that it would serve as a hedge. For every 100 shares of MJ they owned at $20.45, they would be risking a maximum of $2.45 if they owned the January 2020 18 put, or a total of $245. Any amount that MJ fell below $18/share, the put option would make back for them.
It is not a coincidence that the word premium is used to describe an option’s value. They are in fact designed to be just like insurance policies which also have expiration dates. Put options are one of the most common methods of hedging equity positions on mainstream stocks, but just like most insurance policies, most options expire worthless. Most policies reach their expiration without anyone having filed a claim. The policy owner forfeits the premium they paid gratefully since they never wanted disaster to hit in the first place. This will be the case with most put options purchased to hedge any equity holdings. There is not enough liquidity for OWPC options yet though. An investor could look at options on an ETF like MJ that has enough liquidity for investors to consider their put options. An OWPC investor must understand though that the correlation between OWPC and MJ is not 1:1, nor will it stay consistent. It is another alternative though for anyone looking to invest in a company like OWPC and manage their risk exposure.
With time, more risk management strategies will come into play for cannabis holdings like OWPC. Put options make for a way to lock in a maximum risk within designated time frames. There simply is not enough liquidity for options on OWPC quite yet. More inverse ETFs will come with liquidity as well and over time a better understanding of seasonal tendencies and supply and demand factors will bring more hedging alternatives to light. In the meantime, this exciting new sector offers long-term opportunities. Investors should only use discretionary capital and watch positions closely. Searching for companies with strong infrastructures and business plans like OWPC is one of the most important keys for successful investments in the cannabis sector.
Download the PDF here: Hedging Your Investment with OWP
Statements herein may contain forward-looking statements and are subject to significant risks and uncertainties affecting results. TNMNews provides no assurance as to the subject company’s plans or ability to effect proposed actions and cannot project capabilities, intent, resources, or experience. The subject company has reviewed and approved this report. This report is neither a solicitation to buy nor offer to sell securities and is for informational purposes only and shouldn’t be used as basis for investment decisions. TNMNews isn’t an investment advisor, analyst or licensed broker dealer and this report isn’t investment advice. A TNMNews writer has been paid $400 for this report by One World Pharma, Inc. Paid reports constitute a conflict of interest as to TNMNews’ ability to remain objective in communication regarding subject companies. Other articles linked to herein have not been individually vetted for accuracy.