The dicey game of short-selling

K S Badrinarayanan | Updated on July 17, 2020


The astronomical rise in the share price of Tesla Inc caught many short-sellers on the wrong foot and they ended up losing their shirts. According to media reports quoting s3 Partners, a data power company, Tesla short-sellers have lost around $18 billion so far in 2020.

In fact, Tesla founder Elon Musk had, early this month, mocked securities regulators and short-sellers in a series of tweets, after the firm’s market capitalisation at $224 billion zoomed past Toyota to become the most valuable automobile firm.

“Tesla will make fabulous short shorts in radiant red satin with gold trim,” Musk tweeted. “Will send some to the Shortseller Enrichment Commission to comfort them through these difficult times.” Musk, who is famous for his tweets, made another jibe: “SEC, three letter acronym, middle word is Elon's”.

In contrast to Tesla, here in India short-sellers in YES Bank have made handsome gains. Ahead of the FPO price announcement, shares of YES Bank were quoting at a premium in the securities lending and borrowing (SLB) segment. The borrowers sold the shares of YES Bank in the open market with the intention of buying them back when the price fell and squaring-off their positions with neat gains. As their expectation came true and YES Bank shares fell to a low of ₹18 from a high of ₹27.50 within 10 days, short-sellers should have made windfall gains.

Likewise, recently short-sellers in Wirecard at Deutsche Boerse (Germany) also made windfall profits when the company admitted that it had a €1.9-bn hole in its accounts, resulting in a 75 per cent crash in the share price of the fintech company.

Short selling is one area on which market watchdog Securities and Exchange Board of India (SEBI) keeps a close watch and tweaks rules as and when required, as it holds the potential to bring about a catastrophic impact on the market.

Earlier, punters used to make hay in the badla system, where short-selling was easy through a carry forward mechanism by just paying the margin money. However, it was banned in 1993 by SEBI due to its anomalies but partially brought back in 1995, allowing it only for retail investors.

Following extreme conditions of market volatility, SEBI again banned short sales on March 8, 2001. With the introduction of rolling settlement in 414 scrips and discontinuation of all deferral products, SEBI withdrew restrictions for retail investors on short sales. Later in 2008, mutual funds and foreign portfolio investors (FPIs) were also allowed short-selling.

Once again in March 2020, the market regulator tweaked the rules to make short-selling difficult. SEBI said that ‘short positions’ in index derivatives of any entity, including of FPIs, proprietary traders, mutual funds and clients (retail and high net worth individuals) should not exceed their stock holdings. Besides, it increased margin requirements to 30-40 per cent and capped the exposure to derivatives in order to counter the volatility resulting from the Covid-19 pandemic.

The regulator has also cut market-wide position limits of stocks to be put under a ban period from 100 per cent earlier to just 50 per cent.

Short-selling refers to selling (borrowed) shares without owning them to make a profit when they go down in value. Short-selling can be profitable only when one makes a decision that is 100 per cent right. Otherwise, owning short positions carries high risk. According to various studies, only 2 per cent of the whole trade belongs to short-sellers. So, betting against 98 per cent of the market needs a lot of conviction.

Published on July 17, 2020

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