Short-sellers are beginning to make some serious money on bets that the biggest cannabis companies by market capitalization are overvalued.

Since Oct. 16, the day before Canada legalized recreational marijuana, cannabis stocks have been in freefall, with some of the most popular exchange-traded funds covering the sector, the ETFMG Alternative Harvest ETF (MJ), Horizons Marijuana Life Sciences ETF (HMMJ) and Evolve Marijuana ETF (SEED), each falling more than 20%.

Sector-wide losses made short-sellers $450 million in just the first two days of this week alone, financial analytics firm S3 Partners reported, helping bears to cut nearly a third off their year-to-date losses. 

The Big Shorts

In a research note, S3 Partners revealed that the majority of short interest in the sector has been concentrated with only seven stocks having over $100 million in short interest each. Combined, shares of Canopy Growth Corp. (CGC), Aurora Cannabis Inc. (ACB), GW Pharma PLC (GWPH), Tilray Inc. (TLRY), Cronos Group Inc. (CRON) and Aphria Inc. have generated $2.58 billion of short interest, representing 90% of the total $2.87 billion in bets made against the sector.

Rather than voicing his surprise at waning sentiment toward the sector’s big guns, analyst Ihor Dusaniwsky pointed out that short interest in them would probably be higher if it wasn’t for the large fees it costs to bet on their stocks falling.

The average fee on outstanding shorts in the cannabis sector is 15.4 per cent, Dusaniwsky said, with Tilray, one of the most popular stocks, costing 72 per cent to borrow as a result of high demand and a small public float. The analyst added that marijuana short-sellers are now paying over $1.2 million a day to finance their borrow fees.

Lack of Institutional Holders Pushing up Borrowing Costs

“One of the reasons for the high cost is the relative lack of institutional holders in these securities due to the fact that many of these securities trade in Canada or the OTC [over the counter] market in the U.S. which precludes some long only funds from holding them in their portfolios,” wrote Dusaniwsky. “A secondary reason may be the stock’s characterization as part of the “sin-stock” cabal along with tobacco, liquor, gambling and gun stocks which also precludes some long only funds from participating. Once institutional ownership increases in the sector we can expect stock borrow costs to decline significantly.”