What is a Short Delivery?
When one takes an intraday position in the equity segment, whether buy or sell, the position has to be squared off on the same day. Imagine if the position couldn’t be squared off due to some reasons, how it will affect the settlement:
• – If you buy stocks and couldn’t square off then the intraday position will be converted to delivery and you’ll be asked to offset it on the next day, also known as BTST (Buy Today Sell Tomorrow).
• – If you sell stocks (without holding in your demat account) and couldn’t square off on the same day, resulting you’d default to deliver the shares on the prescribed settlement day (T+2). This default is called “Short Delivery”.
Ideally, an equity delivery based trading in India operates in a T+2 i.e. two days after the transaction day, rolling settlement cycle. It simply means that if you buy shares on say, Monday (T day) you receive the delivery on Wednesday (T+2 day). Similarly, when you sell the shares on Monday, you are obliged to deliver the shares on Wednesday. Note that you can withdraw funds only on the settlement day and not on the transaction day.
Let’s take a scenario, assume you have sold 100 shares of Infosys on Monday, 3 January 2016 at Rs. 900 (T day). On Wednesday (T+2), 5 January, you will receive the sale proceed worth Rs. 90,000 (100*900) and your demat account will be debited with 100 shares. However, there’s a twist in the story.
Imagine you don’t have 100 shares of Infosys in your demat account but you still sold them?
No matter what, you have to make delivery of the shares on the prescribed settlement day (T+2) which you have sold on the transaction day (T day). However sometimes it may happen that you take a short position without owning shares in your demat account hence you would not be able to make delivery of the stocks on T+2 and would end up defaulting, resulting a Short Delivery. Now the question here is why do people sell a stock and not deliver it? This happens due to various reasons:
Example 1 – You sold (shorted) 100 shares of Infosys for intraday expecting the price of Infosys to decrease. Note that whenever you sell in intraday position you are required to buy it back (square off) to offset your position. Assume you forgot to square off your position or the square off didn’t happen for whatsoever reason; with this short delivery, you are left with no choice but to deliver 100 shares of Infosys on T+2 days. Since you don’t have any shares in your demat account you would not be able deliver and subsequently default, thereby causing a Short Delivery. However, you’ve got nothing to worry with us! Since Fyers offers you two products to buy/sell in equities namely INTRADAY and CNC.
• : This code used for intraday positions. If you choose this product code while entering the trade, then you do not need to worry because it automatically squares off all your intraday positions at 3:20 pm even if you forget to square off intraday positions yourself. We recommend that you close the positions in order to maintain control over your positions. However, in case you don’t, your intraday position will be squared off by us at the broker level.
• : This product type is used for delivery positions in equities. If you select this code then it will ensure that you hold a sufficient quantity of stocks before selling it.
Example 2 – You were bearish on Suzlon Energy stock assuming the prices will tumble and you shorted it at a price of ₹17 per share. However, in turn the stock exceptionally rallies causing stock price to hit the upper circuit at ₹20. Whenever a stock hits the upper circuit there are no sellers in the market, hence if you’ve short sold the stock you cannot buy it back until it releases from the circuit. This usually happens with a lot of illiquid stocks.
Now imagine the stock is never released during the day! Needless to say, you’d have to hold your short position until you find a buyer, which subsequently results into a Short Delivery. : Stocks which have derivative contracts do not have circuit filters.
WHO CONTROLS THE SITUATION?
It is the Exchange who ensures that the buyer (person who has a buy position) will receive the delivery from the seller (person who has a sell or short position) in the prescribed settlement period (T+2). In case of failure (short delivery as mentioned earlier) the Exchange conducts an Online Auction to buy stocks on behalf of the buyer. Therefore in such cases the long receives the delivery after three days from the transaction day i.e. on T+3 instead of T+2.
HOW AN AUCTION TAKES PLACE?
The auction is conducted by Exchanges every day between 2:00 PM and 2:45 PM. Only member brokers of the exchange can participate and sell shares which are short delivered. To avoid any conflict of interest the exchange doesn’t allow members whose client has defaulted (short delivered) to take part in auction. Let’s examine the auction process:
1. – The Exchange fixes a price range within which the participants offer to sell their shares. The upper limit of the range is set at 20% higher than the price that it closed on the previous day of the Auction whereas the lower limit of the range is set at 20% lower than the price that it closed on the previous day of the Auction. So in the above example, the price range of Suzlon Energy would be fixed at ₹14 – ₹21 (assuming Suzlon Energy closed at ₹17.5 the next day) where the fresh sellers can offer to sell their shares.
2. – The exchange has to buy stocks which are short in delivery at whatever price offered by the fresh sellers. This may cause an extra payment to acquire the shares which subsequently has to be borne by the person who defaults in making the delivery. Moreover, the exchange also penalizes the defaulter by levying 0.05% of the value of the stock per day.
Auction penalty = Excess payment to buy stock + 0.05% of the total transaction value per day.
• The final settlement of the shares is made to the original buyer on the 3rd day from the transaction i.e. on T+3.
• On T+2, the exchange accepts pay-in of securities made by members through depositories and identifies the shortages. The members (usually brokers) are debited by an amount equivalent to the securities not delivered and valued at a valuation price which is known as “Valuation Debit”.
• On T+2, the exchange conducts the auction and purchases the stock from the auction participants on behalf of the defaulting seller.
• On T+3, the exchange gives the shares to the buyer and sends an Auction note to the defaulting broker. The broker then passes on such auction charge to the defaulting client.
How the final settlement is made by the Exchange when there are no sellers in the auction market:
In such cases, the Exchange opts for a cash settlement instead of delivery settlement and makes the payment in cash to the original buyer. Usually, this happens on the basis of close Out rate of the short delivered stock. Close out rate is the highest price of the stock from when you sell to the auction day or 20%, whichever is higher.
Be wary of shorting bullish stocks which can hit upper circuits. Successive upper circuits are a nightmare for short-sellers. Learn more about the price band of stocks on NSE website. Do feel free to ask questions or seek clarifications in the comments section below.
Tejas is the Co-Founder & CEO at FYERS, the youngest team to get NSE’s broker license. He has a specialization in finance and has over 10 years of work experience spanning across proprietary trading, risk management, and broking. Tejas & his team started FYERS, a technology-focused brokerage as a mission to transform the trading/investment landscape in India.