Potential mispricing between MSO Warrants and LP Call Options

Call Options & Warrants

@CCINVEST2 on Twitter made me wonder – are warrants for the MSOs appropriately priced?

I started by taking a step back and looking at 2022 LEAPS for a few of the U.S. listed LPs. In line with what I expected, call options expiring in 2022 imply breakeven prices that trade roughly 40% to 90% above current levels.

Looking at Canopy, its LEAPS with a $20 strike price expiring in 2022 require a ~40% price appreciation to breakeven. This has been relatively consistent over the past six months.

What’s interesting, despite warrants being structurally identical to call options (though with specific parameters set by the issuer), the MSOs imply a different upside. In my small sample size, warrants for TRUL, AYR.A, and PLTH each trade right at the breakeven price.

Looking at the breakeven on Trulieve’s warrants, the required price appreciation is just 3.2%, mainly by way of the recent increase in Trulieve’s stock price.

I highlight the discrepancy between the LPs and the MSOs because typically the optionality to purchase at a pre-determined price in the future lends itself to a premium.

Black Scholes Model

One method for valuing options/warrants is the Black Scholes Model. While it might appear complicated, it is actually quite simple. Outside of expected volatility, every input is already provided. This can be calculated in Excel, but I used the calculator on myStockOptions.com.

For Trulieve’s expected volatility, I used 50.15%, which is the figure that management used when pricing its share-based compensation during Q2’20.

I also used today’s 10-year treasury yield as the respective risk-free rate.

U.S. Department of the Treasury

Indicated by the inputs below, the Black-Scholes value for Trulieve’s warrants amounts to $15.55, in line with trading current prices.

On the contrary, Canopy’s 2022 LEAPs with a $20 strike trade at $5.50, or 53% higher than the Black-Scholes Value of just $3.60.

Conclusion

From what I can tell, LEAP call options on the LPs through 2022 appear to be overpriced when compared to a few of the MSOs. Depending on the election, we could see the LPs rally and extend this discrepancy, but it makes me think that a reasonable risk-adjusted bet would be to write call options on the overpriced LPs to finance long positions in warrants on the MSOs.

Disclaimer: I have no intention on selling options on the LPs. I am a long only investor with a very long time horizon. This is just an interesting observation I wanted to pass along.