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Nov 9, 2018

S3 Analytics: Cannabis Short Sellers Nearly Recoup Wednesday’s Losses

Cannabis stocks rallied over 8% yesterday on euphoria that Attorney General Jeff Session’s resignation would bode well for U.S. cannabis policy. Today, clearer minds prevailed and cannabis stocks gave back most of yesterday’s run-up when investors realized the likelihood that there would be short term legislative changes to federal cannabis policy was unlikely.

With the cannabis sector rallying in 2018, short sellers have added almost $1.4 billion of exposure since mid-year, hoping for a reversal in what they believe to be an over-heated and over-valued sector. Short interest is now $3.35 billion in the 141 securities we track in our cannabis basket. While short interest in the sector continues to grow in 2018, exposure is very extremely concentrated, with 94% of the short interest in only 10 securities.

Shorts were down $292 million in mark-to-market losses Wednesday, -8.69%, which were almost totally wiped clean with Thursday’s $265 million in mark-to-market profits, +7.90%. We can expect more days of high volatility in cannabis as hopes for legalized U.S. marijuana sales grows with the newly elected Democratic majority in the House of Representatives. Along with these high hopes and spikes in stock price are more days of price reversals which will entice shorter term momentum short sellers to jump in and out of the market.

We can expect more momentum short trading in the more largely shorted, more liquid and larger capitalized securities such as Canopy growth Corp (CGC US & WEED CN), Aurora Cannabis (ACB US & ACB CN), Cronos Group (CRON US & CRON CN) and Tilray Inc (TLRY US).

While short selling and timing the cannabis market may be a profitable endeavor, there is a steep cost to enter the trade. Overall stock borrow costs are very high, with the average stock borrow fee in the sector being 13.44% fee and short sellers spending nearly $1.3 million per day in stock borrow financing costs. Several of the most shorted cannabis stocks have very high borrow costs with TLRY at 38% fee, CRON at 42% fee and TGOD at 50% fee. The seven remaining stocks in the top ten range from 0.57% fee to 5.94% fee.

Cannabis stock short sellers remain active and resolute in their conviction even though they are incurring year-to-date losses and paying high stock borrow fees and we are not seeing significant buy-to-covers in any of the most shorted name. As more long shareholders appear in stock lending programs stock loan rates should decline over the long term and short selling of cannabis stocks should become more attractive to a large set of short sellers as financing costs take a smaller bite out of net Alpha . And as price volatility and momentum continues to increase in the sector, short sellers will become more active entering and exiting their positions as shorter term trades become larger Alpha generators.

We should expect short selling in the cannabis sector to continue to grow, providing a slight counterbalance to the long buying frenzy and also providing trading liquidity in some of the less broadly traded securities.

Want deeper insight into the above analysis?
Contact:  Ihor.Dusaniwsky@S3Partners.net
                 Managing Director Predictive Analytics, S3 Partners, LLC
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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