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Stocks

Short Selling Stocks Will Soon Be Allowed

SEBI has decided to allow institutions to short-sell. Meaning they can sell before the own the shares, by “borrowing” shares from the market. How does this impact us?

Short selling has been derided all through history, and even the big traders like Jesse Livermore got a bad name in the early 1900s because of it. Yet, short sellers are the stabilizers in the market – if the market drops dramatically you need the short sellers because they will buy and book profits and thus keep the market from going too far down.

So how can you short sell? You borrow shares from someone, paying them a small premium for the period that you borrow. Then you short sell the shares, and keep the position open. (Currently, retail investors are allowed to short sell, but only on an intra-day basis, meaning they can’t keep the short position open beyond a day). At some point you can decide to square off, and buy the shares at the current price, and return the shares to the one you borrowed from.

If the lender decides that he wants the custody of the shares, at any time for any reason, he can demand it back from the short seller, who has to provide them by buying from the market. So if you short sell, you can get a demand for your share and you have to make good on the request immediately.

SEBI proposes that both retail and institutional investors will be allowed to short sell. They are approaching it half heartedly though, only stocks in F&O will be short-sellable. That is not of too much use, you can already short sell futures. But this is a good offsetting mechanism, and is very useful for arbitrage funds, since they can now make money even in a bear market. (when futures are priced lower than the spot market, they can buy a future and short sell the stock)

You can make money too by lending your shares to the short sellers. We’ll have to see how this mechanism pans out but it could help with some income on your long term picks as well.

Is this new? Of course not, there was a system called ALBM till 2001, which was scrapped after the Ketan Parekh scam. But this time the regulator looks like they have their act together in a better way.

Watch this space and SEBI for more action. No timelines are announced yet and it could take till mid-2008 before things actually happen.

I’ve been travelling so I apologise for not posting much. I am moving to Mumbai in Jan and am in Delhi currently, so it’s been a whirlwind month. What’s interesting is that the market has moved to my advantage and since I left for the trip I have actually made some money on the short position I had, and I will probably hold to expiry. Happy holidays, by the way!