What is short selling of shares?

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What is short selling of shares?
Short selling, is a complex and advanced form of trading strategy, wherein an investor can sell shares that he currently does not holds in his portfolio. Though, it sounds quite bizarre, the process is executed by borrowing shares deemed as overpriced from the broker and selling them in an expectation that the market price of the share would go down.

Eventually, the same numbers of shares are purchased at low rates and returned to the borrower and the position of short sell is covered in the technical parlance. In the process, the investor earns profits and lender of the security earns a fee.

Short selling illustrated in the following example: An investor short sells a scrip X at the price of INR100 and covers the X scrip (buys) when the price of the scrip declines to INR 90, making a profit of INR10 in the transaction.

Short-selling transactions governed by SLB programme:

The short-selling of shares in the Indian securities market is governed by the SEBI's Securities Lending and Borrowing (SLB) programme introduced in the year 2008.

The Indian securities market requires investors performing short selling to compulsorily settle their transactions basis the securities held and owned by them. Furthermore, institutional investors are barred from indulging in intra-day trading.

Investors permitted to short sell

The short-selling of shares is permitted to all investor classes by the SEBI, including retail, institutional investors such as foreign institutional investors (FIIs) and domestic mutual funds that are registered with the SEBI, and insurance and banking companies. However, for such a trading transaction, investor need to maintain minimum margin requirements.

As per the Reuters report, only lately the Securities and Exchange Board of India (SEBI) relaxed rules relating to short-selling of shares in the Indian securities market. With such a relaxation, several other scrips meeting different eligibility norms such as an average monthly turnover of a minimum of INR1 billion would come within the ambit of the securitieslending and borrowing (SLB) programme.

Significance of Short-selling

It is suggested that short selling of securities aids in the price corrections of over-valued scrips and also provides for liquidity. Consequently, discovery of efficient price for different scrips is provided with the help of short-selling.

Despite the relevance of short selling in the securities market, it is viewed as a risky trading strategy that could destabilize the securities market and further worsen the declining price scenario being witnessed in the securities market.

GoodReturns.in

Read more about: shares, sebi
Story first published: Thursday, July 11, 2013, 12:57 [IST]
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