Contrarian Clues from the Cannabis Sector

Judging by the amount of headline ink, daily trading volatility, and general breathlessness generated by cannabis stocks in recent months, we would tend to agree with the Wall Street pundits who have recently observed that "weed is the new crypto" in terms of sector hype. But then again, there's no need to take our word for it; the rampant investor appetite for marijuana stocks is sufficiently self-evidenced by the ballooning daily share volume in names like Canopy Growth (CGC) and Cronos (CRON), as well as the booming interest in NASDAQ newcomer Tilray (TLRY).

Over the past month, this growing enthusiasm has also been expressed in the form of inflows totaling $84.74 million into the ETFMG Alternative Harvest ETF (MJ), per etf.com data. This exchange-traded fund (ETF) -- which counts CGC, CRON, and TLRY as its top three holdings -- now has over $562 million in assets under management.

And MJ hasn't escaped the notice of the speculative crowd, either. As of Friday, put open interest on MJ hit a new high of 85,920 contracts, while call open interest set its own peak of 17,746 contracts. Last Thursday was actually the second-biggest put volume day of the year for MJ, as upwards of 22,000 contracts were exchanged. Accordingly, with interest in the fund's option contracts heating up, premiums were also surging; early Friday morning, Trade-Alert registered a new high in MJ's 30-day at-the-money implied volatility of 72.1%. (That compares to the ETF's 30-day historical volatility of 54.7%.)

From a broader perspective, the heightened volatility in the marijuana sector was helped along on Friday by a Politico report indicating the U.S. would implement lifetime travel bans on Canadian cannabis industry workers and investors attempting to cross the border, just ahead of the northern country's legalization of the drug on Oct. 17.

But while the Politico headline was credited for a broadly negative open for pot stocks on Friday, it's worth pointing out that no new changes or rules were reported within the content of the article. Instead, the author wrote that U.S. border officials will "continue to apply long-standing federal laws and regulations," and observed that the groups most likely to be impacted include truck drivers and Canadian nurses working in U.S. hospitals who are also marijuana users.

Given that, it's fair to say that the early losses in the sector Friday were an overreaction -- and names like Canopy Growth and Cronos did recover from their morning lows rather capably. Tilray, on the other hand, opened down big and stayed down big, while the broader MJ fund split the difference, eking out a positive finish after wobbling around the breakeven line for most of the session.

In cases where there's a widely hyped and "trendy" sector in the spotlight, watching the reactions of individual stocks to these types of "big" headlines can be very instructive, from a sentiment perspective. The securities that have been most heavily targeted by the bandwagon players (those who, in another era, might have bought WorldCom shares on a tip from their cabbie) are the most likely to be disproportionately punished by even the tamest of "negative" headlines, which can provide very valuable clues for contrarian traders looking to enter a crowded field without getting stampeded.

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, September 16.