1. Learn with FE: How Stock Lending & Borrowing Scheme reduces short selling risk

Learn with FE: How Stock Lending & Borrowing Scheme reduces short selling risk

Traders who short sell a stock with an objective to gain from the intraday trade, but are unable to buy it back at the time of delivery, land up without shares at the end of the day to square off their positions. But the stock exchange has undertaken the guarantee for settlement of every trade.

By: | Published: May 1, 2017 10:07 AM
A short seller enters into a trade expecting the price of a share to fall later in the day. The objective behind such a trade is to sell a share at a particular price and then buy the same stock at the end of the day at a cheaper price. (Image: Reuters)

In order to maximise returns in the securities markets, traders and investors often enter into activities which invariably expose them to high risk. One such activity is short-selling, which leaves traders with very high risk if they fail to buy the shares and square off their positions at the end of the day.

Short selling involves selling a stock that the trader does not own at the time, but which, they can buy later same day before the end of the trading session, so that the Stock Exchange and clearing houses can proceed with the settlement.

The ultimate risk arises when the short seller fails to square-off the short position by the time the market closes for the day. This may happen due to several reasons, such as unavailability of a trade because of less volatility in a particular stock, or simply, the trader failing to buy the shares due to mismatched trade timings.

More on short selling

Short selling is done to gain from the spread from “buying the security at lower price and selling at higher price”. A short seller enters into a trade expecting the price of a share to fall later in the day. The objective behind such a trade is to sell a share at a particular price and then buy the same stock at the end of the day at a cheaper price.

Short selling can be done by borrowing the stock through clearing corporation / clearing house of a stock exchange, which is registered as Approved Intermediaries (AIs). Short selling can be done by retail as well as institutional investors. All the securities listed in the future & options segment are available for short selling.

Short selling was never a bad practice in theory, but sometimes, traders fall prey to market rumours or malicious information or false news about a company. Traders or brokers who short sell a stock with an objective to gain from the intraday trade, and are unable to buy it back at the time of delivery, fall into trouble, landing up without shares at the end of the day to square off their positions. But the stock exchange has undertaken the guarantee for settlement of every trade. So what to do now?

Relief Window

As an investor protection initiative and to give a relaxation to approved intermediaries which are doing short selling on behalf of their clients, both the main bourses of India NSE & BSE introduced a scheme called Security Lending and Borrowing Scheme (SLBS).

The Security Lending and Borrowing mechanism allows short sellers to borrow securities for selling short. Security Lending and Borrowing allows other investors to lend shares through clearing corporation / clearing houses of stock exchanges, in return for interest on their idle securities in lieu of helping out the investors / traders who want to undertake a short sell trade. The short trader buys the stock back later and returns to the original lender with interest, regardless of the change in the share price during this time.

There is an obvious advantage to the lenders as they can make extra gain through lending the securities which they hold in adequate amount. If the participation in the scheme increases across the investor base, it will enhance the popularity of SLBS window and diversify traders’ access to the shares, which would otherwise not be readily available.

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