Marijuana stocks rank as some of the market's most shorted stocks, and short-sellers are paying dearly for the right to borrow them. As a result, investors who own marijuana stocks can collect massive fees for lending out their shares to short sellers, often as much as 20% of the stock's value on an annual basis.

High borrow fees aren't limited to just the smallest marijuana stocks. The following table shows borrow fees on popular marijuana stocks as of Jan. 22, 2018.

Marijuana Stock

Borrow Fee (Annualized)

Kush Bottles (NASDAQOTH:KSHB)

73%

Aurora Cannabis (NYSE:ACB)

71%

Aphria (NASDAQOTH:APHQF)

29%

Insys Therapeutics (NASDAQ:INSY)

29%

Data source: IBorrowDesk.com, which tracks borrow fees at Interactive Brokers.

Stock lending used to be purely institutional, but more retail brokers are allowing individuals to participate, sharing the fees on hard-to-borrow stocks with their clients. E*Trade and Fidelity call it "fully paid lending." Charles Schwab calls its arrangement a "securities lending fully paid program." Interactive Brokers pitches securities lending as its "stock yield enhancement program," roughly splitting the fees from stock lending with its clients 50-50.

How it works

To sell a stock short, short-sellers first have to borrow the shares from someone who owns them. When there is more demand to borrow a stock than supply, the fees can soar to as high as 100% of the stock's value on an annual basis. People who own these heavily shorted shares can cash in by collecting a fee by lending them out.

Lending out shares isn't entirely risk-free, though it may be worth the risk when fees are especially high. In most cases, your broker stands as the counterparty. If your brokerage firm were to go under, there is a risk, although small, that you would not be able to recover the shares you lent out in full. 

That said, I'm not aware of anyone losing money by lending out their shares, as the collateral is marked to market daily. Besides, if you own any mutual funds or ETFs, it's likely you're already participating indirectly in securities lending without knowing it. Popular marijuana ETFs like the Horizons Marijuana Life Sciences Index ETF (TSX:HMMJ) (NASDAQOTH:HMLSF) lend out their shares to generate incremental returns for their investors. Approximately 41% of its stock holdings were lent out as of its most recent interim report.

Marijuana leaf resting on top of a $100 bill.

Image source: Getty Images.

To be sure, marijuana stocks are an outlier for their high borrow fees. Not all stocks are worth lending out, and it may not make sense to lend out some dividend-paying stocks held in a taxable account. When you lend out dividend-paying stocks, the borrower is required to pay you payments in lieu of dividends on the shares, which are taxed as ordinary income rather than qualified dividends, which are generally taxed at a lower rate than income.

Some brokers gross up stock lending fees to cover the theoretical tax difference, while others do not. Of course, most marijuana stocks don't pay dividends, and won't pay dividends for some time to come, so this point is moot for most pot stock investors. In addition, the stock lending fees are so large for pot stocks that the stock lending fees would almost certainly make up for any tax difference on dividends.

Nearly free money?

Over the past year, shares of Kush Bottles have more than doubled, and those who lent out their shares received double-digit lending fees on an annualized basis as the stock gained in value. Its investors could have earned a double-digit cash return from stock lending fees while benefiting from the stock's rising value, assuming they lent out their shares. 

Keep in mind that Kush Bottles is a favorable example. Making money isn't as easy as buying stocks that are hard to borrow and lending them out for lending fees. After all, short-sellers are willing to pay so much to borrow stock for a reason: They expect the stock to drop at a faster rate than the fees add up.

Some people don't like the idea of lending out their shares to help someone bet against them, but I think that's a mistake. I lend out all my stock when I can, even if the lending fees aren't as lucrative as the sky-high fees on marijuana stocks. If you're going to take the risk of investing in stocks that the market views with extreme skepticism, why wouldn't you want to be fully compensated for taking the risk?

Jordan Wathen owns shares of Interactive Brokers. The Motley Fool recommends Interactive Brokers. The Motley Fool has a disclosure policy.