What Is Shorting in Stock Market? - A Complete Guide | Espresso

All You Need to Know about Shorting in Futures & Options

Shorting is just a simple market view. Just like people purchase stock when they expect it to go up, they sell it when they expect it to go down. It's normally a directional outlook and nothing else.

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Let's say a person owns 2000 shares of Tata Motors and expects the stock to correct sharply due to JLR's poor performance. What would they do? They would sell the inventory and wait for a better price to enter later. What if they didn't own the stock? The answer is that they can also short the stock without delivering the stock.

When to short a stock? There are two options: one can either short on the spot market or futures market. We got you covered in this blog. Here’s everything you need to know about Shorting in Futures and Options.

What is Shorting?

Shorting, or short selling, is a trading method in which a trade is opened with a sell order in anticipation of a down market movement. Short positions are common practice for experienced traders, but there are significant barriers to shorting certain assets for new traders. One of the most obvious benefits of futures trading is that it allows traders of all levels to sell in their preferred markets easily.

How Can You Sell a Stock If You Don't Own It?

There are two ways to sell a stock without owning it:

  • First, you can short sell in the spot market. Note the intraday shorts here. This means that if you sell a stock in the morning and cannot deliver it, you must cover (buy) the position before the close of the day's trade. The Indian market operates on T+2 rolling payments. This means these promotions will be shipped automatically if you do not call the position on the same day. So, if you sell in the morning and don't pay it back by evening, you have to get your stock back. Keep this important point in mind when short selling in the spot market.
  • Second, shorting a stock is easy in the futures. In the case of Tata Motors, if you don't have stock delivery and still want to sell the stock, you can try selling Tata Motors Futures. There is no pressure for you to fill the position by the evening. You can choose between 1 month, 2 months, and 3-month futures. Liquidity is usually only limited to the first 2-month contracts, and as such, you may need to roll over your positions. But your pay-out will be the same as if you sold the stock if the price falls because futures prices and spot prices are closely matched.

Shorting in Spot Market

Short selling on the spot market has one limitation, it must be done on an intraday basis. This means that you can initiate the short trade anytime during the day, but you must purchase back the shares by the end of the day before the share market closes. You cannot carry the short position forward over multiple days. To understand why spot shorting is strictly an intraday affair, you should know how the exchange treats the short position.
Also Read: Intraday Trading Time Period Analysis

When you are shorting on the spot market, you are clearly selling first. When you are selling a stock, an internal process notifies the exchange that you have sold a specific stock. It does not differentiate between the general sale (in the Demat account) and the short sale of stocks. From their point of view, they believe you sold the stock, so you should offer the same. To do this, you should have the stock in your Demat account ready for the next day. However, the exchange will only know about your obligations after the market’s closing and not during market hours.

Shorting in the Futures Market

Short selling shares in the futures sector does not have the same restrictions as selling shares in the spot market. In fact, this is one of the most important reasons why futures trading is so approved. Remember, a “future” is a derivative that simply mimics the movement of its underlying asset. So, if the underlying price goes down, so does the futures. This means that if the stock is bearish, you can short the futures and hold the position overnight.

Conclusion

So, similar to posting margin when taking a long position, the short position would also require posting margin. Margins are similar for long and short positions and don't change. Short selling futures is very similar to buying futures, except that you can only profit when the price goes down when you are shorting.
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Frequently Asked Questions

Although short selling seems like an easy way, selling futures may be the best option if you have a negative view of stocks. When selling on the spot market, sales are limited to one day only. However, the price movement may not occur on the same day, so you need to close the position at a loss. Therefore, selling futures is your best bet.

The biggest benefit of selling futures is that you can sell stocks and indices such as Bank NIFTY and NIFTY. So, you can look at the market or sector as a whole and replay this trend through indices. In other words, it cannot be sold on the spot market.

You can only sell a stock short on the cash market during the day. To understand why this is so, we need to understand how the exchange treats a short transaction. 

When you short a stock, the stock market doesn't differentiate between a short sale and a regular stock sale. It treats both equally. However, in the case of a short sale, one would have to have the shares ready for delivery. 

For this reason, short selling should only be done on an intraday basis. This means that if you're shorting a stock, you should buy it back before the end of the day. But if you fail to do so, you have to pay a heavy fine. This penalty could be 20% more than your short price.