Short selling is a concept where you make profits from declining stock prices. In general sense when you buy a stock you expect the prices to go higher but when you are shorting a stock you expect the price of the stock to fall. Shorting a stock is a risky mechanism as theoretically there is no limit to how much the price of a stock can rise. As here you are betting against the company and predicting that the prices of the stock would fall, your losses would increase if the price of the stock increases and hence the losses may also be unlimited. When the investor believes that the value of a stock would decrease at a future date, he opens a position by borrowing shares or stocks. A position is an established or entered trade which is yet to be closed with an opposing trade.
Let’s say for an example a short seller borrows 100 stocks of a company at Rs.100 per share and sells them for the cash of Rs.10,000. The price of the share now declines to Rs. 40 per share and the short seller buys 100 stocks at this price for Rs.4,000. The profit that the short seller has now made is Rs. 6,000. On this transaction certain brokerage fees and lending fees may be levied.
In India, short selling was banned by the Securities and Exchange Board of India (SEBI) in March 2001. However, after the ban ‘retail investors’ were allowed to short sell and in 2005, ‘institutional investors’ were allowed as well.
According to SEBI regulations, lenders have the discretion to call back the borrowed stocks at will. SEBI is also pushing towards physical settlement without reviving the mechanisms of Securities Lending and Borrowing (SLB). The SLB mechanism is a system where investors are allowed to borrow shares that they do not own from brokers for the purpose of short selling. There is no incentive to borrow stocks under SLB as the stocks provided are similar to those under futures and options and the futures are already provided for the same.
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