Why in the News?
The Securities and Exchange Board of India (SEBI) is considering a proposal to ease restrictions on short selling in most stocks.
SEBI’s January 2024 proposal to bar short-selling in stocks that are not in the futures and options segment had caused uncertainty.
What is Short Selling?
- Definition: Short selling is a strategy where an investor sells a stock first and buys it later, aiming to profit from a price drop.
- Opposite of Normal Trade: Unlike regular buying (buy low, sell high), short selling works on selling high and buying low.
- How It Works: You borrow the stock from a broker, sell it at the market price, and later buy it back at a lower price to return it.
- Example: If a stock is sold at ₹2,100 and later bought at ₹1,900, the profit is ₹200. If the price rises to ₹2,300 instead, the loss is ₹200.
Types of Short Selling:
- Short Selling in the Spot Market (Cash Segment):
- Shorting is allowed only for intraday trading (buying and selling financial instruments (like stocks) on the same day).
- You must square off the position (buy back the stock) before 3:30 p.m. on the same day.
- If not squared off, it leads to short delivery, where the exchange settles the trade through an auction.
- There may be heavy penalties if the position is not closed on time.
- Short Selling in the Futures Market:
- Here, you can hold your short position overnight or even roll it over to the next month.
- You must deposit margin money, which is generally higher.
- Futures shorting is riskier and is mostly used by experienced traders.
- This type allows more flexibility but involves greater financial commitment.
Risks Associated with Short Selling:
- Unlimited Losses: If the stock price rises sharply, losses are unlimited.
- Short Delivery Risk: Failing to buy back in the spot market can lead to penalties.
- Liquidity Risk: Hard-to-trade stocks may lead to delayed buybacks and losses.
- Margin Requirements: High margin costs in futures trading limit retail participation.
- Market Volatility: Sudden movements may cause unexpected losses.
- Not for Beginners: Due to complexity and high risk, short selling is unsuitable for new investors.
| [UPSC 2025] Consider the following statements:
Statement I: As regards returns from an investment in a company, generally, bondholders are considered to be relatively at lower risk than stockholders. Statement II: Bondholders are lenders to a company whereas stockholders are its owners. Statement III: For repayment purpose, bondholders are prioritized over stockholders by a company. Which one of the following is correct in respect of the above statements? (a) Both Statement II and Statement III are correct and both of them explain Statement I (b) Both Statement I and Statement II are correct and Statement I explains Statement II (c) Only one of the Statements II and III is correct and that explains Statement I (d) Neither Statement II nor Statement III is correct |
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