The fine art of Short Selling

The stock market, which has just undergone a big correction, is likely to witness a big change soon. In a bid to deepen the market and increase liquidity, market regulator Securities and Exchange Board of India (Sebi) and the government are mulling over the possibility of allowing short selling by institutional players. What Short selling is the practice of selling stocks without the seller owning them at the time of trading. The seller—who wants to make profit by driving down prices—later buys the stock to square up the transactions. While individual investors are allowed short selling, the restriction on institutional players is seen as a dampener. Though Secondary Market Advisory Committee of Sebi has recommended removal of restrictions on short selling in December 2005, a final decision is awaited soon. Why Short selling helps to create efficient markets for stocks by allowing prices to be influenced by everyone who has an opinion on a stock. But many experts also complain that traders use it to drive down prices in what they call Bear attacks. That said, it can be used to better price efficiency and improve liquidity. How In its discussion paper on short selling in December 2005, Sebi had recommended that short selling will have to go hand-in-hand with a scheme for stock lending and borrowing. This is because an investor who indulges in short selling would have to borrow or arrange for securities to ensure delivery within the specified settlement period. Who The Sebi paper had proposed institutional investors should be permitted to short sell in order to provide a level playing field. However, the RBI had put a dissent note to the proposal of allowing FIIs to short sell as it can create sudden turbulence in the external sector. When The regulator is expected to announce the measure shortly as the market has been witnessing huge swings of up to 5-6%. The 6th What Next Short selling by hedge funds can be a big risk as bigger markets like the US had bitter experiences. The regulator is likely to put certain checks and balances against misuse. It is also unlikely to allow day-trading—intra-day squaring up of transactions—by institutional players. Simultaneously, the government is likely to bring down the futures trading volumes by individual investors by asking them to make delivery on the expiry day. The regulator is also expected to come out with a revised stock lending and borrowing system.