Why is it in the News?

The Supreme Court judgement records a statement made by Solicitor General Tushar Mehta that the Union government and the Securities and Exchange Board of India (SEBI) will take measures to regulate short selling.

What is Short Selling?

• Short selling is a financial strategy where an investor or trader borrows securities, such as stocks, from a broker and sells them in the market with the expectation of buying them back at a lower price in the future.
• Short selling is regulated by a circular notified by SEBI in December 2007.
• This technique is employed by individuals who anticipate a decline in share prices, aiming to profit from their predictions.
• The process involves selling shares that the trader does not own.
  • To initiate a short position, the trader borrows shares from a broker, who lends them with an agreement for return at the settlement time.
  • The borrowed stocks are then sold at the prevailing market rate, creating a short position.
  • Subsequently, the trader waits for the prices to decrease before buying back the shares to close the position.
  • The ultimate goal of short selling is to 'sell high and buy low.'
• Profits are made when share prices fall, and the trader benefits from the difference between the selling and repurchasing prices.
  • Conversely, if the trader's analysis is incorrect and share prices rise, they incur a loss.

How Does Short Selling Work?

Short selling is an activity that allows market participants to profit from the fall in the price of a financial instrument. It involves borrowing an asset from a broker, selling it in the market, and then repurchasing it later at a hopefully lower price to return it to the lender.

• Borrowing the Asset: The trader borrows the asset (usually stocks) from a broker or another trader.
  • This borrowed asset is typically done through a margin account, where the investor agrees to certain terms and pays a fee or interest for the borrowed amount.
• Selling the Asset: After obtaining the borrowed asset, the trader immediately sells it on the market.
  • This is where they take advantage of their belief that the asset's price will decrease.
• Waiting for Price Drop: The trader waits for the price of the asset to fall. If the price drops as anticipated, the investor can buy back the asset at a lower price.
• Repurchasing the Asset: Once the price has dropped, the trader uses the proceeds from the initial sale to repurchase the same asset at a lower price.
• Returning the Borrowed Asset: Finally, the trader returns the borrowed asset to the lender, typically the broker, from whom they originally borrowed it.
• Profit or Loss: The profit or loss in short selling is the difference between the price at which the asset was sold and the price at which it was repurchased, minus any borrowing fees, interest, or transaction costs.

Short selling is considered a more advanced and riskier trading strategy, and it requires careful monitoring of market conditions. It is often used by experienced investors or hedge funds seeking to profit from anticipated price declines in specific securities or markets.