The Hindu Business Line : Of short sale and proposed changes in it

SEBI's Secondary Market Advisory Committee (SMAC) in its recent report has suggested a change in the definition of short sales. What is short sale and what is the implication of the proposed change in the definition?

Short sale is defined as selling a stock without owning it. This strategy is adopted when a trader expects the stock to decline.

Suppose you sell a stock at Rs 45 in the morning, and buy it back at Rs 40 before the day's close.

You have violated the SEBI regulation because you have engaged in short selling. Note that you can, however, buy a stock and then sell it the same day without violating any regulation.

Many traders do nevertheless engage in short selling. The reason is that stock exchanges find it very difficult to monitor such sales. This is one reason why the SMAC has proposed a change in the definition of short sales.

The committee proposes to define short sales as a transaction that does not result in delivery. This means that you can first sell the stock and buy it back at a lower price during the day without violating any SEBI regulation.

But what if the stock does not fall enough for you to profit from the transaction? Instead of buying from the market, you can, for a fee, borrow the shares and deliver them against those you sold.

At a later date, you can buy the shares from the secondary market and deliver the same to the person from whom you borrowed.

So, whom will you borrow from? The SMAC has proposed a clearing corporation to facilitate the process of stock lending.

This entity will bring together stock borrowers and lenders, just as the stock exchange brings together all buyers and sellers.

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