Regulators worldover recognise short selling as legitimate, now it’s time for us to get going...
You can sell what you do not own; this may sound queer for the uninitiated, but then it is not far from reality. Investors can now ‘officially’ make money on a decline in an individual stock or during a bear market, thanks to the advanced investing technique termed ‘short selling’.
A long standing market practice, short selling (or shorting, if you please) has been a subject of considerable debate. Of late,
market regulator Securities and Exchange Board of India (SEBI) has permitted all types of investors, including retail and institutions, to undertake short selling after a gap of six years. It had been banned in 2001, post the ruckus created by Ketan Parekh in the stock market. Some are quick to add that short selling has been re-introduced in order to stem the rampage of the bull and to provide players, mostly institutional, the opportunity of cashing in on the ebb as well.
As a concept, short selling is neither complex nor entirely simple. The market regulator defines it as “selling a stock which the seller does not own at the time of trade.” Simply put, it is the practice of selling financial securities that the seller does not own, in the hope of repurchasing them later at a lower price.
Strategically, it allows investors to gain from the decline in price of securities, much against the common perception of purchasing a security in the hope that prices will increase.
There are divergent views with regard to short selling. Avid supporters are of the view that most of the scandals in the stock market involve alleged attempts by the promoters of companies to rig share prices. It not only helps in providing liquidity, but also helps in price corrections of over valued stocks. Agrees F.A. Sarkar (Sharekhan) “it is the absence of short-selling that distorts efficient price discovery, which in turn gives promoters the freedom to manipulate prices.”
However critics are of the opinion that short selling poses inherent risks which can destabilize the market. According to them shorting can increase price volatility, can lead to the company’s stock price reaching such a low that it impacts the company’s fund raising abilities and thereby undermine the confidence of the company. Nevertheless, securities regulators across the globe have accepted short selling as a legitimate investment activity by persistently recommending transparency measures, as opposed to prohibiting it altogether.
Speculation and hedging are the two primary reasons cited by brokers as to why investors will prefer short selling. To bring about an easy mechanism for lending and borrowing of shares, SEBI has decided to put in place a full-fledged securities lending and borrowing (SLB) scheme for all market participants in the securities market. Further, SEBI has asked stock exchanges and depositories to put up a “fool proof system” in place for the new products and has accordingly made it mandatory for traders to honour the obligation of delivering the shares at the time of settlement. This will ban naked short selling. Adds Santosh Mandal (Simon & Cailand Pvt Ltd), “by increasing the width, the intent is to make the capital market more vibrant… making the wrong calls will be the greatest risk.” Of course, short selling offers a risky method of making money from falling stocks, but it’s a gamble... you can well walk away with a neat profit when prices go down. Sounds obnoxious, but that’s short selling for you.
You can sell what you do not own; this may sound queer for the uninitiated, but then it is not far from reality. Investors can now ‘officially’ make money on a decline in an individual stock or during a bear market, thanks to the advanced investing technique termed ‘short selling’.
A long standing market practice, short selling (or shorting, if you please) has been a subject of considerable debate. Of late,
market regulator Securities and Exchange Board of India (SEBI) has permitted all types of investors, including retail and institutions, to undertake short selling after a gap of six years. It had been banned in 2001, post the ruckus created by Ketan Parekh in the stock market. Some are quick to add that short selling has been re-introduced in order to stem the rampage of the bull and to provide players, mostly institutional, the opportunity of cashing in on the ebb as well.As a concept, short selling is neither complex nor entirely simple. The market regulator defines it as “selling a stock which the seller does not own at the time of trade.” Simply put, it is the practice of selling financial securities that the seller does not own, in the hope of repurchasing them later at a lower price.
Strategically, it allows investors to gain from the decline in price of securities, much against the common perception of purchasing a security in the hope that prices will increase.
There are divergent views with regard to short selling. Avid supporters are of the view that most of the scandals in the stock market involve alleged attempts by the promoters of companies to rig share prices. It not only helps in providing liquidity, but also helps in price corrections of over valued stocks. Agrees F.A. Sarkar (Sharekhan) “it is the absence of short-selling that distorts efficient price discovery, which in turn gives promoters the freedom to manipulate prices.”
However critics are of the opinion that short selling poses inherent risks which can destabilize the market. According to them shorting can increase price volatility, can lead to the company’s stock price reaching such a low that it impacts the company’s fund raising abilities and thereby undermine the confidence of the company. Nevertheless, securities regulators across the globe have accepted short selling as a legitimate investment activity by persistently recommending transparency measures, as opposed to prohibiting it altogether.
Speculation and hedging are the two primary reasons cited by brokers as to why investors will prefer short selling. To bring about an easy mechanism for lending and borrowing of shares, SEBI has decided to put in place a full-fledged securities lending and borrowing (SLB) scheme for all market participants in the securities market. Further, SEBI has asked stock exchanges and depositories to put up a “fool proof system” in place for the new products and has accordingly made it mandatory for traders to honour the obligation of delivering the shares at the time of settlement. This will ban naked short selling. Adds Santosh Mandal (Simon & Cailand Pvt Ltd), “by increasing the width, the intent is to make the capital market more vibrant… making the wrong calls will be the greatest risk.” Of course, short selling offers a risky method of making money from falling stocks, but it’s a gamble... you can well walk away with a neat profit when prices go down. Sounds obnoxious, but that’s short selling for you.
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Source : IIPM Editorial, 2008
An IIPM and Professor Arindam Chaudhuri (Renowned Management Guru and Economist) Initiative
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