Short selling is a crucial strategy in stock trading, allowing investors to profit from bearish market trends. Short selling can help traders hedge the downside risk of their securities. In short selling, traders borrow shares from the stock exchange, sell them in the open market, and later repurchase them at a lower price to return to the lender, making a profit in the process.
However, failing to buy back shares to lenders in the stipulated time frame can result in short deliveries. In this blog, we will explore the short delivery meaning, its implications for traders, and the auction procedure involved.
Understanding Short Delivery
In the Indian stock market, shares are typically delivered to a buyer’s demat account within one trading day after the transaction (T+1 settlement). Short delivery occurs when a seller fails to deliver shares to the buyer’s demat account in this timeframe. Short delivery often happens when traders hold intraday short positions but are unable to close them due to market conditions such as a stock hitting the upper circuit and becoming illiquid.
Additionally, brokers allow traders to sell shares even before they are credited to their demat account, expecting to receive them by T+1. However, if the exchange is unable to deliver the shares, it leads to short delivery, indicating that the seller has defaulted on their obligation.
How Short Delivery Works?
Now that you know the short delivery meaning, understanding how it works is essential. Short delivery occurs when a trader fails to fulfil their obligation to deliver shares within the stipulated timeframe. This can happen in situations where short sellers are unable to square off their intraday positions, leading to a delivery failure.
Another common scenario arises when traders sell illiquid stocks they do not own. If the stock hits the upper circuit, preventing them from repurchasing it, they are unable to return the borrowed shares resulting in short delivery.
To resolve this, the exchange conducts an auction on Tuesday (T+1 day) to purchase short-delivered shares. The broker applies a short delivery tag to the stock on Wednesday (T+2 day) if shares are not delivered on Tuesday. The exchange delivers shares purchased from the auction market on Tuesday (T+1 day) and makes their delivery on Wednesday (T+2 day).
How Does Short Delivery Impact Traders?
Short delivery makes the most impact on intraday traders as they can face penalties, lose trading licenses, and face other legal actions if they do not meet the deadline for settlement of shares.
One major impact of short delivery is the disruption of market liquidity. If sellers fail to deliver the required shares, it creates a supply shortage, driving up stock prices due to increased demand.
In extreme cases, when a stock hits the upper circuit, traders may find it difficult to execute transactions at their desired prices, further affecting market efficiency.
Understanding Auction of Shares
If the exchange is unable to find new sellers during the auction process, the short-delivered shares will be closed out. Instead of delivering the shares to the buyer, the exchange compensates them through a cash settlement based on the close-out rate.
The close-out rate is determined as the higher of the highest price of the stock between the trading day and auction day, or 20% above the official settlement price on the auction day. The buyer will receive this compensation from the seller’s end due to the non-delivery of shares.
The below example can help you understand how short delivery impacts traders:
Consider a buyer who purchases 100 shares of TATA Steel at ₹200 each, but the seller fails to deliver them by T+1 day. To resolve this, the exchange organises an auction to find alternate sellers who can provide the 100 shares.
If fresh sellers are available, the shares are delivered to the buyer. However, if no sellers are found, the exchange closes out the transaction and compensates the buyer based on the applicable close-out rate.
How Does Auction of Shares Work?
Continuing with the previous example, let us understand how the auction process works in case of short delivery.
Suppose the closing price of TATA Steel on the trading day (Monday) was ₹280. The exchange uses this price to determine the auction price range.
The auction price range will be ±20% of the closing price:
- Lower limit: ₹280 – (20% of ₹280) = ₹224
- Upper limit: ₹280 + (20% of ₹280) = ₹336
If there are no sellers, the exchange enforces a close-out settlement, to compensate the buyer on the highest price between the trading day and auction day or 20% above the official settlement price, whichever is higher.
Impact of Short Delivery Auction on Traders
Understanding the auction of shares is crucial for traders, as it plays a key role in managing short deliveries and ensuring smooth market operations.
Continuing with our example:
- Suppose the auction price for TATA Steel is ₹300 per share.
- The original trade price was ₹200 per share for 100 shares.
- The seller incurs an auction penalty calculated as:
(Auction Price – Original Trade Price) × Quantity
= (₹300 – ₹200) × 100 = ₹10,000
As a result, the buyer will receive:
- ₹28,000 (100 shares × ₹280, the settlement price on auction day)
- ₹10,000 as compensation due to the price difference (auction penalty)
- Total amount credited: ₹38,000
The exchange will credit the shares to the buyer’s demat account on T+3 days, ensuring settlement completion.
Final Thoughts
Understanding short delivery and the auction of shares is essential for traders who engage in short selling. If traders fail to buy back the shares they have sold short in an intraday transaction, it can negatively impact their trades.
A short delivery occurs when sellers do not deliver the full amount of stocks to buyers, resulting in a shortage of shares in the market. This shortage causes prices to rise, which increases the demand for purchases.
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