An auction market is a market in which buyers indicate the highest price they are willing to pay and sellers indicate the lowest price they are willing to accept. A trade occurs when the buyer and seller agree on a particular price.

Now before we move on let us describe, in brief, what is Short Selling and BTST.

Short Selling

Short selling is the selling of a stock that the seller doesn”t own. More specifically, a short sale is the sale of a security that isn”t owned by the seller, but that is promised to be delivered. Short selling is motivated by the belief that the price of the security will decline, enabling it to be bought at a lower price to make profit. However, there is infinite risk of loss in short selling and only used by experienced traders who are familiar with the risks.

BTST

In BTST, you can buy a stock today and sell it tomorrow before the delivery of the shares (Since in India we follow a T + 2 settlement cycle when trading stocks). Suppose you buy 100 shares of XYZ Company on Monday, 29th December. You would get its delivery on Wednesday (T+2) evening. Ideally, you could sell it from Thursday. However, with BTST, now you can now sell your shares on Tuesday or Wednesday morning as well. You can then deliver the shares after it reflects in your demat account (Since settlement cycle is T+2 days).

Defaulting on delivery- Short Delivery

As explained, in India, delivery based equity trading has a T+2 rolling settlement cycle. That means, if you purchase a stock on say Tuesday (T), you will get the delivery of the stock (It will be credited to your demat account) on Thursday evening (T+2). Similarly, if you sold a stock on Tuesday you are required to deliver the shares by Thursday after which the proceeds from the sale will be credited to your account.

Now, suppose you sold 100 shares of XYZ Company (trading at Rs. 145) on Monday, 29^th December. You will deliver the shares by 31^st December morning and receive sale proceeds (Rs 145*100= Rs 14,500) by Wednesday evening. Suppose, you do not have 100 shares of XYZ Company in your demat and hence on Wednesday you default on the delivery of the shares. This default is called ‘short delivery’.

Now, you must be wondering how/why anyone would sell a stock that they do not own. There are several instances where this can happen:

• In case of intraday sale transactions without a square off positionSuppose you short sold 100 shares of XYZ Company for intraday expecting its price to fall. Now assume you forgot to buy back these shares. But you will have to deliver these shares on T+2. Since you do not own these share you will default on delivery.
• Selling a share for Intraday but the stock hits upper circuit that daySuppose you short sold 100 shares of XYZ Company for intraday expecting its results to be bad. However, a favourable news made the stock hit an upper circuit the entire day (when a stock hits the upper circuit, there are no sellers in the market). There is no way that you can now buy back these shares. Hence, you are forced to hold your short position and would have to deliver the shares, failing which the shares would be short delivered.
• In BTST (Buy today, Sell tomorrow) transactions in which you did not get the deliverySuppose in a BTST transaction (where you sell before receiving the delivery of the share) the person who sold the shares to you does not deliver the share. Since you did not get the delivery of the shares, you will also fail to deliver to the person you sold to.

In all these cases of Short Delivery, the person selling the share is at fault. However, the person who bought the share should get the delivery. To ensure this delivery, Exchange conducts an auction and buys these shares from the auction market and delivers it on T+3 instead of T+2.

Auction market- What, when and who?

Auction market is a special market where only members of exchange can participate as fresh sellers for the quantities short delivered and the Exchange is the sole buyer. The Auction market is conducted every day between 2:00 PM to 2:45 PM IST. A Member who has failed to deliver the securities of a particular company on the pay-in day is not allowed to offer the same scrip in auction. The Members, who participate in the auction session, can download the Delivery Orders in respect of the auction obligations on the same day, if their offers are accepted. The Members are required to deliver the shares in the Clearing House on the auction Pay-in day, i.e, T+3. Pay-out of auction shares and funds is also done on the same day, i.e., T+3.

Price in Auction market

A price range is specified by the Exchange within which the auction participants can offer to sell their shares.

• Upper Limit: 20% higher than the closing price on the previous day
• Lower Limit: 20% lower than the closing price on the previous day

So a seller can offer to sell the shares of XYZ Company in the range of Rs 120 – Rs 180 (assuming the previous day(T+1) closing price was Rs 150).

Auction Process

Coming back to the above example, since you did not deliver 100 shares of XYZ Company that you sold, the Exchange will now buy these shares in the Auction market and deliver on your behalf.

Scenario 1: Price of the stock on T+1 is Rs 150 and in Auction market selling price is Rs 175

Exchange has no option but to buy at the price on offer and deliver the shares to the buyer. Since you defaulted, you will have to pay the difference Rs (175-145)*100 = Rs 3,000 to the Exchange. Along with this, the Exchange also charges an additional penalty of 0.05% of the value of stock per day that you failed to deliver. The sum of both the above is called the ‘Auction Penalty’.

Typically, in your books of accounts, you would have received a credit of Rs 14,500 (145*100) as sale proceeds, and since you failed to deliver a debit of Rs 17,500 (175*100) thereby resulting in a loss of Rs 3,000 + additional penalty on the transaction.

The entire process:

29th Dec	T	You sell the shares at Rs 145
31st Dec	T+2	You fail to deliver the shares
31st Dec	T+2	Since shares are not delivered, the Exchange blocks a sum of money called ‘Valuation Debit’ from your Broker’s account. Valuation Debit is the closing price of the stock on T+1 (30th December). So Rs 15,000 (150*100) is the debited
31st Dec	T+2	Stocks are purchased in the Auction market on behalf of you
1st Jan	T+3	Exchange delivers the shares to the buyer and sends an Auction note to your broker who then passes the auction charges to you.

Scenario 2: Price of the stock on T+1 is Rs 140 and in Auction market selling price is Rs 130

Assuming that after you sold the stock at Rs 145, the stock price falls to Rs 140 on T+1. The entire process in this scenario will be:

29th Dec	T	You sell the shares at Rs 145
31st Dec	T+2	You fail to deliver the share
31st Dec	T+2	Valuation Debit of Rs 14,000 (140*100) is debited from the Broker’s account (Closing price on T+1)
31st Dec	T+2	Stocks are purchased in the Auction market at Rs 130 on behalf of you
1st Jan	T+3	Exchange delivers the shares to the buyer and sends an Auction note to your broker who then passes the auction charges to you.

The price in the Auction note is mentioned as ‘The higher of Valuation debit or the price at which the stock has been bought in the Auction market.’ In this scenario, the exchange will debit the broker’s account with a sum of Rs 14,000 even though the stock was purchased at Rs 13,000 (130*100). The difference of Rs 1,000 [(140-130)*100] is transferred to Investor Protection Fund.

However, if the stock was bought at Rs 160 in the Auction market, the Exchange would debit an additional Rs 2,000 [(160-140)*100] over the Valuation debit from the Broker’s account.

Scenario 3: No sellers in the Auction Market

In such a scenario, the Exchange settles this in cash on the basis of close-out rate. Close-out rate is higher of the following

• The highest rate of the scrip from the day of trading (T) to the day of Auction (T+2)
• 20% above the closing rate as on the day of Auction

Suppose the highest rate of the scrip from the trading day to the day of Auction was 180 and the closing rate on the day of Auction is Rs 170.

So you will have to pay a penalty of Rs 5,900 [(204-145)*100], using 20% above Rs 170.

Some ‘Closing-out’ scenarios

1. Closing out in case of failure to give delivery for Trade-for-trade – Surveillance (TFT-S) deals

In Trade for Trade segment, the settlement of scrips is done on a trade for trade i.e., delivery basis and no netting off is allowed. Criteria for shifting scrips to/from Trade for Trade segment are decided jointly by the stock exchanges in consultation with SEBI and reviewed periodically.

Any shortages in TFT-S will be directly closed-out on settlement at the highest price prevailing in the Exchange from the day of trading till T+1 day or 20% above the closing price on the T+1 day, whichever is higher, or as declared from time to time.

In such situations, it is strongly advised to have a look at the series of the Stock which it belongs to, whether it is BE (in case of NSE) or T (in case of BSE) before entering into the trade. Trade for Trade series is meant for delivery only and any intraday trade in any stock in this series would result into disaster. The sell transaction would result into delivery failure, if the stock is not already lying in the Demat account whereas the buy transaction would result into the pay out of the share on T+2.

2. Closing out in case of failure to give delivery in Auction Market

When the auction seller fails to deliver in part or full on the auction pay-in day, the deal will be closed out at the highest price prevailing in NSE from the day on which the trade was originally executed till the day of closing out or 20% over the official closing price on the close out day, whichever is higher and will be charged to the auction seller unless otherwise specified.

3. Compulsory Close-out of securities under Corporate Action

In cases of securities having corporate actions and no “no-delivery period” for the corporate action, all cases of short delivery of cum transactions which cannot be auctioned on cum basis or where the cum basis auction payout is after the book closure / record date, would be compulsory closed out at higher of 10% above the official closing price on the auction day or the highest traded price from first trading day of the settlement till the auction day.

Practical Tips

• Always check before placing the order whether the scrip is in Normal or Trade for Trade settlement.
• Suppose you buy 100 shares of ITC on T day. On T+2 day, you get 98 shares from exchange and 2 shares fall short. Now you sell 100 shares of ITC on T+3 day morning, on the hope that you will get the short delivered 2 shares by end of T+3 from the exchange (since auction settlement on T+3). In many cases, where the short quantity is very small like 2, 3 etc., exchange generally closes out the transaction and issues cash credit because generally there is no seller available in auction market for selling only 2 or 3 shares. So, in that case, you will face delivery default on T+5 to the extent of the said 2 or 3 shares.
• If you buy any uncommon, low volume and fundamentally strong stock and if it comes short from the exchange, do wait for the shortage settlement from the exchange – because in many such cases you will find a handsome close out credit instead of shortage payout. If you wish, you may again buy the stock immediately after the shortage settlement.