The financial market is full of various avenues for every kind of investors. The participation in such markets depends on the interest levels of an individual in a certain type of trading.Sometimes trading mistakes are made and have to be paid for. Such an instance is where the process of auction is a consequence of an investor’s default.
This article is dedicated to auctions as a consequence of default in the Indian stock market, please continue reading to know and understand in detail.
Meaning of Auction
Auction is the process of sale where potential buyers place their respective bids to purchase a given asset or service. At the same time, the seller of the asset or service makes an offer up to his lowest bid in order to sell. The two prices are matched and the buyer’s highest bid matching the seller’s lowest offer price confirms the purchase.
Auctions are also held in case a stock trader defaults in his trading conduct in the market, or in cases of Initial Public Offers by companies. The process of an IPO auction is known as Dutch auction.
Auction in the Indian Stock Market
The stock market conducts an auction of shares on a daily basis throughout a trading week. The stares to be auctioned off consist of shares that were sold by a trader and not delivered within the stipulated window of time.
Auction in Case of Short Sales
In the equity market, retail traders use a trick to lock and earn profits called short selling of shares. Short Sales occur when a trader sells of shares he doesn’t actually possess. To know more about short sales, you could read our detailed article “What is Short Selling? ”
For example, a trader is supposed to receive his purchased shares on Wednesday on the basis of T+2 days system. He sells off his shares on Tuesday itself, considering that he would be able to transfer his shares to BSE/NSE on Thursday. Technically, a trader must have the shares available in his Demat Account in time to make the transfer. But if due to some circumstance, should the trader fail to deliver his shares on the T+2days, such a transaction will result in “default in paying obligation: and immediate auction of his shares.
Participants and Timing of Auction
The Indian Stock Market holds auctions for shares of defaulting traders, here in the case of short delivery. Such auctions are held between 2:00 pm to 2:45 pm. The participants of the auction consist of member brokers of the exchange only. The defaulting client cannot make an offer in the same script.
The auction pricing depends entirely on the share price at the closing of the previous trading day. The lowest auction pricing that can be done is 20% below the closing price of the day prior. Also, the auction price can be no more than 20% above the closing price of the shares from the previous day.
Process of Auction
The BSE/NSE informs the members about the auction of named securities in default. The said auction is conducted on the time stated where the members place their respective offers to buy. When the offer entry session is closed randomly between 2:45 to 2:46 pm, the bidders whose offers are accepted can download the Delivery Orders in respect of the auction obligation on the very same day. The buyer of such shares will be delivered their shares in T+3 days.
Let’s assume Mr. Das has defaulted by way of short delivery of 10 shares at ITC Ltd priced at Rupees 100 per share.
The broker of Mr. Das had to deliver these shares to the exchange on the T+2days, and since he failed, the exchange blocks a sum of money from the broker’s account after notifying him of the short delivery. This sum is called valuation debit.
Assuming the closing value of the shares on T+1st day to be Rupees 150, the exchange blocks Rupees 1500 from the broker’s account.
There are three possible outcomes of this auction:
- The shares are sold high:
The highest bid for the shares was made at Rupees 190. The stock buys the shares and gives them to the buyer. Since the seller is at default, the difference between valuation and selling price is to be paid by the seller.
Difference = SP – Auction Price
Rs 1500 – Rs 1900
Difference = Rs (400)
- Share price dropped at sale:
The shares were sold to the highest bid of Rupees 120. In such a case the benefit of rupees 300 would not be passed to the defaulting seller in order to discourage short selling. The gain of 300 would be transferred to the Investors Protection Fund.
- Close out session:
The shares not purchased are deemed closed out and are settled in cash from the seller. The price to be paid is the highest price prevailing from the day of trading till the auction day, or 20% above the closing price on the day prior to auction, whichever is higher.
An auction is profitable from the buyer’s point of view but in case of short sales does not do well for any trader. A successful stock trader learns to sell short by delivering within the stipulated time through online trading, where one does not depend on a broker. There are several online trading portals one can use, such as Indira Traders who help through share investment advice and expert services.