Short Selling Allowed – A big step forward for Indian Stock Markets

Short selling is allowed again in the Indian stock markets. Sebi today issued a circular allowing short selling, with a securities lending and borrowing mechanism to be put in place. The stock exchanges and depositories will be the implementing agencies, they have been asked to make the necessary amendments in their own statutes, develop and test software for the same. Sebi will notify the date from which short selling is allowed after the agencies confirm their preparedness for the same.

What is proposed?

  • Both retail and institutional investors will be allowed to short sell.
  • Naked short selling is not permitted. Seller will have to borrow stock to meet deliveries.
  • Institutional investors will continue to be prohibited from day trading.
  • Only those stocks that are in the F&O segment (to begin with) will be allowed to be sold short.
  • A Securities Lending and Borrowing Mechanism will be put in place, before short selling becomes a reality.
  • The tenure of lending/borrowing shall be fixed as standardized contracts. Initially, 7-day contracts may be introduced, according to the Sebi circular.
  • The settlement cycle for borrowing and lending mechanism will be trade plus one day
  • Importantly, any borrowing or lending of securities will not be treated as transactions that will affect FDI/FII limits, or share acquisition or other disclosures. That means anybody can participate, even promoters it would appear.
  • SLB transactions will be disclosed on a weekly basis to begin with

What will it achieve? Short selling is just another way for a trader to make money. Short sellers take big risks, go against the market, and it is said that successful traders make more profits by shorting stocks than by buying them. It is said to control volatility in markets. If certain stocks witness unusually large rises, a short seller will short the stock, hoping that the stock will fall to its intrinsic value, and he will gain in the process. Thus, buyers will have to test their strength against short sellers, who will try to hammer stocks down. Short selling may create volatility by itself. This is a paradox, but short sellers can beat down a share price sharply, as much as a group of bulls can sharply bid it up. While a share price going up 200% attracts envy among those who were bystanders, when a share falls by 70%, those holding shares will inevitably cry foul. It attracts more regulatory scrutiny than buying does, as a result. Short selling makes the Indian markets more perfect. It is being introduced at a time when our markets are at a high. The risk is that if markets decline sharply at some time, due to whatever reasons, short selling may end up taking the blame. Short sellers lose money for a long time, but when they sense victory, they close in for the kill and show no mercy. Old-timers in Indian stock markets are accustomed to short selling, in the days when badla was allowed. The difference this time is the existence of a derivatives market where there was only a cash market earlier. So, people have been going short in the derivatives market. The interplay between the derivatives market and the cash market will change after short selling gets introduced.

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