Shorting in spot (The stock exchange’s perspective)
Shorting in the spot market has to be done on an intraday basis – you can start a trade anytime during the day but must make sure you close it prior to markets closing. This is because of how the exchange views short positions, and it doesn’t allow for multiple days.
When you short in the spot market, you firstly need to put up a sale. Once you have done that, the exchange will be alerted of your position – regardless if this has come from your DEMAT account or as part of as short sale. The exchange doesn’t make distinctions between the two and is of the belief that you have sold shares which obligates you to provide these. To fulfil this requirement, you must have these stocks in your DEMAT account by the following day; however, the exchange won’t become aware of this obligation till after market close.
Reflect on the above points. Now suppose that you have shorted a stock and anticipate the price dropping. You wait, yet it remains high so you decide to leave it. When market close, the exchange notes that you sold during the day and hence expect to pay delivery. Unfortunately, you do not own these shares so cannot complete your obligation; this is called “Short Delivery” and there will be a hefty penalty for defaulting.
Under a short delivery scenario, the exchange will take on the problem and resolve it in the auction market. I’d suggest looking into this article on Z-Connect; it covers auction market regulations and penalties imposed on clients who are unable to fulfil their delivery obligations. A warning: always make sure your short trade is closed prior to market close, or you risk being charged as much as 20% more than your initial short price.
This brings us to an important point in mind – the exchange conducts a ‘obligation check’ after the market closes. Consequently, if shorting is done with a plan to cover it beforehand (by squaring off), no obligations will remain when the day is over. Hence, it is necessary to carry out shorting in spot markets as an intraday trade only, not taking delivery into account.
Does that then mean you don’t have to close a short position within the day? Not necessarily. You can leave a future market short position open overnight if desired.
– Shorting in the Futures Market
Shorting a stock in the futures segment has no restrictions like when trading it on the spot market. People favour this market for such an ability – as futures are derivatives that simply mirror the underlying asset’s behaviour. Thus, when its value is decreasing, so is the futures’, allowing traders to hold short positions overnight if they are bearish about said stock.
When initiating a long or short position, a margin deposit is required. The margins are consistent and do not differ between the two types of positions.
To comprehend the concept of ‘Mark to Market’ (M2M) when shorting futures, let us look at an example. Taking HCL Technologies Limited as a reference, assume you have shorted it at Rs.1990/- with a lot size of 125. The table below indicates the stock price trend and its corresponding M2M values over the next few days –
The two lines in red clearly demonstrate losses. In order to calculate total profitability of the trade, we can simply sum up all the M2M values.
+ 1000 + 875 – 625 – 1125 + 2375 + 625
Alternatively, we could look at it as –
(Selling Price – Buying price) * Lot Size
= (1990 – 1965) * 125
Shorting futures is quite similar to initiating a long futures position, since the margin requirement and M2M calculation is identical. The primary difference is that you will only make profit should the price happen to decrease.
Shorting is an essential element of active trading, so I would recommend getting as comfortable with initiating a short trade as you would if buying long.