Back in December, I made a somewhat controversial marijuana stocks pair trade recommendation. Pair trades are a way for traders to make a long bet on a specific thesis while hedging against broader market or sector weakness.
I recommended traders go long three top Canadian legal cannabis producers (LPs) and short three cannabidiol (CBD) stocks. The trade was essentially going long tetrahydrocannabinol (THC) and short CBD.
Roughly eight months since my recommendation, the pair trade has worked like a charm. The cannabis group has struggled. But the CBD group has performed even worse, allowing pair traders to generate a decent overall gain.
Here’s a look back at the original trade and an updated version looking forward.
Pair Trading Marijuana Stocks
Just as a brief introduction, TCH and CBD are two of a long list of chemical compounds that occur naturally in cannabis. CBD produced from hemp was legalized in the US in December 2018. It didn’t take long for CBD to pop up in thousands of products everywhere throughout the country.
CBD enthusiasts claim it provides a wide range of health and wellness benefits. A quick Google search will reveal people claiming CBD treats treats cancer, diabetes, arthritis, menstrual cramps, anxiety, psychosis, dry skin, dementia, Alzheimer’s, depression, anger, Crohn’s, ADHD, PTSD, IBS, Parkinson’s opiate addiction, migraines, and general pain.
At the same time, pretty much everyone agrees that THC gets you high.
Consumer enthusiasm for CBD products exploded last year. Despite all the anecdotal evidence of health benefits, the U.S. Food and Drug Administration is clear about its stance on CBD. Here’s what the FDA had to say in March of 2020:
“The FDA has approved only one CBD product, a prescription drug product to treat two rare, severe forms of epilepsy… The FDA has seen only limited data about CBD safety and these data point to real risks that need to be considered before taking CBD for any reason.”
I’m not claiming that CBD doesn’t have positive medical benefits. Clearly it can help with epileptic seizures. But I’d be willing to bet it does far less than companies marketing it say it does. And the more scientific testing is performed, the more likely it will be linked to negative side-effects as well.
Marijuana Stocks: The Original Trade
I’ve been a long-term bull on marijuana stocks. But to me the real long-term value in cannabis is THC, not CBD. CBD seems more like a fad. Experienced traders know fads rarely work out well for long-term investors.
So my idea back in December was to go short CBD-focused marijuana stocks CV Sciences (OTCMKTS:CVSI), Charlotte’s Web Holdings (OTCMKTS:CWBHF) and cbdMD Inc (NYSE:YCBD). At the same time, I recommended pairing that trade with long positions in Canadian LP’s Canopy Growth (NYSE:CGC), Cronos (NASDAQ:CRON) and OrganiGram (NASDAQ:OGI).
Since that trade idea was published, the short CBD group is down an average of 22.1%. The long THC group is down an average of 16.3%.
This is exactly the result that a pair trader is hoping for. Going long those Canadian LPs would have resulted in a 16.3% loss. However, the pair trade resulted in a net gain of 5.8%. In that same time, the S&P 500 index gained just 3.1%.
If constructed properly, pair trades are extremely low-risk trades because they are hedged in both directions. So traders are likely never going to get huge returns. But a proper pair trade also protects against significant downside as well.
Updated Trade Idea
The November 2020 U.S. election will likely be a huge catalyst for marijuana stocks. I still believe THC, not CBD, will be the big long-term winner.
However, I want to slightly adjust the pair trade a bit. I’ll stick with the three CBD shorts: CVSI, CWBHF and YCBD. I’ll also stay long CGC and OGI. But I’m going to substitute U.S. multi-state cannabis operator Cresco Labs (OTCMKTS:CRLBF) for Cronos on the long side. Cresco is a U.S. business that would benefit directly from any election-related momentum. In addition, the company has major opportunities to expand capacity in Illinois and Pennsylvania in the second half of 2020.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book Beating Wall Street With Common Sense, which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan was long CGC.