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This Little-Known Way to Profit From Short Sellers Is Worth Exploring

By Dan Caplinger - Jun 25, 2021 at 5:33PM

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Markets are moving to all-time highs, and short sellers are skeptical. Here's how shareholders can pocket some extra cash.

The rising stock market, and especially the explosive moves higher in some stocks, has prompted many institutional investors to look to short selling as a way to make money. Short sellers  hope that the price of a stock will go down rather than up, as they borrow stock from shareholders and then sell it at current high prices. If the price drops, then they can repurchase the shares, return the stock to the original owner, and pocket the profits.

But there are a couple ways short sellers can lose money. One is obvious: If the stock price moves higher, then they'll have to pay more to replace the shares, taking extra money out of their own pockets. What's less well-known is that brokers can charge short sellers to borrow a stock that's particular popular as a short-sale candidate -- and increasingly, ordinary investors like you and me can get a chunk of that cash to keep for ourselves.

Person holding fan of cash.

Image source: Getty Images.

How the market fared on Friday

The stock market kept up its upward trajectory for the most part on Friday, with the S&P 500 (^GSPC 0.19%) setting another record high. The Nasdaq Composite (^IXIC 0.00%) fell just short with a modest decline, but the Dow Jones Industrial Average (^DJI 0.71%) posted the biggest gains on a percentage basis despite remaining a couple percentage points below its all-time record level.

Index

Percentage Change

Point Change

Dow

+0.69%

+237

S&P 500

+0.33%

+14

Nasdaq Composite

(0.06%)

(9)

Data source: Yahoo! Finance.

Borrow rates and short selling

In order for short sellers to open a position, they have to find shares of stock to borrow. For highly liquid blue-chip companies, it's trivial to find institutions willing to lend shares, and there'll be little if any cost for short sellers pay to borrow stock.

However, when less liquid stocks become popular short-sale candidates, borrow rates can rise substantially. For example:

  • Traders on the popular WallStreetBets discussion board cited a borrow rate of 57% on health insurance tech provider Clover Health Investments (CLOV -1.23%) as of Friday morning.
  • Shares of the electric vehicle start-up Arrival (ARVL 3.68%) featured even higher borrow rates, rising to nearly 80% as of Friday morning.

What this means is that investors borrowing $10,000 worth of shares of these companies have to pay fees of $5,700 to $8,000 per year to maintain their short positions. Many short sellers don't hold their positions open that long, but you're still looking at hundreds of dollars in fees just for a month in some cases. As a result, even if the short seller turns out to be right about the direction of the stock, the fees can eat heavily into any profits.

Getting your share

In the past, brokers were happy to keep all those fees for themselves. Most margin account agreements had customers give away their rights to securities lending fees to the broker in exchange for low or no commission stock trading.

Now, though, many brokers offer securities lending programs in which customers can get a share of the revenue from securities lending to short sellers. For instance, one broker essentially splits the revenue 50/50, giving customers half of the borrow fee generated from their holdings. Other brokers have different terms, so it pays to talk to your broker to find out the specifics.

Essentially, securities lending programs give brokerage customers a way to profit from the short sellers who are betting against the stocks they own. If you find yourself owning stocks that have been short-selling targets, it might be worth it to look into whether you can add some income by participating in such a program.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Clover Health Investments, Corp. Stock Quote
Clover Health Investments, Corp.
CLOV
$3.21 (-1.23%) $0.04
Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$34,152.01 (0.71%) $239.57
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
^GSPC
$4,305.20 (0.19%) $8.06
NASDAQ Composite Index (Price Return) Stock Quote
NASDAQ Composite Index (Price Return)
^IXIC
$13,128.05 (0.00%) $0.00
Arrival Limited Stock Quote
Arrival Limited
ARVL
$1.41 (3.68%) $0.05

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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