The Hindu Business Line : What is short selling?

According to the market regulator, the traders would be required to mandatorily honour the obligation of delivering the shares at the time of settlement.

Our Bureau

Chennai, Dec. 23 The Securities and Exchange Board of India last Thursday allowed short selling for all class investors for which it is working on stock lending and borrowing scheme (SLB), for settlement of securities. The date of implementation will be announced after the stock exchanges and depositories put the required systems in place, SEBI had said.

But short selling is not a new concept for the Indian investors, as it was prevalent till March 8, 2001; SEBI had to impose ban on short selling following huge fall in stock prices triggered by Ketan Parekh then.

Here goes glossary on short selling

What is short selling?

According to Investopedia.com, “Short selling is the selling of a stock that the seller doesn’t own. More specifically, a short sale is the sale of a security (whose price is presumed to go down) that isn’t owned by the seller. Once the stock price goes down, the seller buys it again from the market and settles the transaction.

“When you short sell a stock, your broker will lend it to you. The stock will come from the brokerage’s own inventory, from another one of the firm’s customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later you must ‘close’ the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.”

Why one should go for a short?

There are two reasons behind that: To speculate and to hedge

Investopedia.com says “the most obvious reason to short is to profit from an overpriced stock or market. Probably the most famous example of this was when George Soros ‘broke the Bank of England’ in 1992. He risked $10 billion that the British pound would fall and he was right. The following night, Soros made $1 billion from the trade. His profit eventually reached almost $2 billion.”

Hedging is protecting other long positions with offsetting short positions.

What is naked short selling?

The illegal practice of short selling shares that have not been affirmatively determined to exist.

“Ordinarily, traders must borrow a stock, or determine that it can be borrowed, before they sell it short. However, some professional investors and hedge funds take advantage of loopholes in the rules to sell shares without making any attempt to borrow the stock,” says Investopedia.com. This causes the trade not to be completed.

So, what is the problem with it?

The problem with naked short selling is that it can be abused to make profits at the expense of share prices. To do this, the trader simply enters a naked short with no intention of returning the shares, thus leaves the transaction incomplete. However, a large enough short sale could cause the price to fall, just as a large deal where the stock is being really sold.

So, this time SEBI has disallowed it?

Yes. According to the market regulator, the traders would be required to mandatorily honour the obligation of delivering the shares at the time of settlement. This means naked short selling cannot be done.

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SEBI allows short selling by institutional, retail investors
Marketmen welcome SEBI move on short-selling

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