What is short selling and how does it work?

If you expect the stock price to go up, the choice is quite simple. You either buy the stock for delivery and hold it in your demat account or you buy the futures, if available in F&O. But what if you have a negative view on the stock? You can sell futures or you can even buy a put option. But what if the stock is not available on F&O? Short selling could be the answer.

What is short selling all about?

Normally, the rule with any asset is that you can only sell what you own. That means, you must have clear delivery in your demat account before you can sell the stock. But can you sell without delivery? That is possible in the equity markets; but only on an intraday basis. Short selling is possible in all stocks that are not in the “Z” group or in the Trade to Trade (T2T) segment.

Rolling settlement stocks have to be settled on a T+1 basis. That means, if you sell the stock today then you need to give delivery from your demat account next day morning. However, delivery is applicable if your net position is negative at the end of the day. That means; if you sell the stock and buy it back same day, it will be treated as an intraday trade. In that case, you don’t need to give delivery and only the profit or loss will be adjusted to your trading account. That is what short selling is all about.

How does short selling work?

Short selling is about selling a stock and then buying it back before the end of the trading day. You have a 5-6 hours window to close out your position. Short selling is deployed when you expect the stock price to go down during the day. There are 3 steps to short selling.

• While placing the sell order, you must select the option MIS (Margin intraday square-up) which will tell the system that it is a short-sell order.
• Intraday order entails payment of margins. However, margins can be reduced by placing a Cover Order (CO) or a Bracket Order (BO). In a CO, you add a stop loss and in BO you add stop loss order and profit target.
• Short selling orders (intraday) have to be mandatorily closed out same day. Brokers run an RMS check around 3.15 pm and close out pending orders automatically.

Scenarios in short selling

Once you short sell a stock, there are three possible scenarios.

• You sell the stock and it goes down. For example, you sold 500 shares of RIL at Rs1,100 and are down to Rs1,080. You can book profits of Rs10,000 and close out.
• You sell the stock and it goes up. If the stop loss is placed then it terminates the position automatically. You can also stop out earlier to cut losses.
• You place a sell order and the stock does nothing for first 4 hours. You can choose to close out to avoid last hour volatility. Of course, you may lose some money after brokerage and statutory costs.

Benefits and risks in short selling

Let us look at the benefits of short selling first. It allows you to make profits on a negative view on the stock, even if you don’t own it. Secondly, if you have shares in your demat account, you can use that as margin to short sell. In a worst case scenario, you can give delivery. Thirdly, short selling allows you to apply negative view on non-F&O stocks.

What are the risks? In a volatile market, your stop losses may get triggered higher and add to your losses. Although the broker runs RMS on intraday positions, the onus is on you to close out positions. If you forget to close out and the system fails, the stock goes into auction and can result in huge losses. Be wary of that!