How failed short-selling bets in Groww shares led to huge losses for traders

Shares of Groww are in focus, not for delivering investors with huge returns, but for huge losses. As the majority of the investors who were allotted shares of Groww in the IPO are rejoicing in its bumper listing and a relentless post-listing rally of nearly 90%, some short-term investors and traders are facing losses of up to ₹100 crore. Some short-term traders and investors saw an opportunity to short Groww’s shares after its 90% rally, but are now facing huge losses for their inability to deliver shares after squaring off their position. The fiasco has highlighted how the shorting mechanism works when short sellers fail to deliver the obligated quantity of shares. Let us delve deeper into the shorting and e-auction mechanism.

What is short selling of shares?

Some investors and traders are bullish about a particular stock and expect the price to appreciate further. Similarly, some investors and traders are also bearish on the stock price and expect the price to fall from the current level. The ones who are bullish buy those shares and sell at the desired price for profit, thus participating in the rally. Similarly, investors or traders who want to participate in the correction of the share price sell the shares at a higher price and buy them back at a lower price. The difference between the selling price and the buying price is the profit of a short seller. A short seller borrows shares and sells them at a higher price, and while squaring off, he delivers them back to the lender.

What went wrong in the Growws case?

Groww’s share price jumped from ₹110 apiece on listing day to ₹194 apiece in mere five trading sessions. Such a euphoric rise attracted short sellers for a shorting opportunity. Like an usual transaction, short sellers shorted Groww’s shares for a profitable opportunity. Like a short-selling trade, a seller sells the shares and delivers them the next day by buying back. Additionally, in Groww’s case, the liquidity of shares was limited owing to restrictions on selling shares for institutional investors after listing. The Groww’s free float was nearly 7% of the overall shares of the publicly traded, making trapping them for liquidity. As the share price continued to rally, the short sellers had to run to save money as their losses mounted.

The auction mechanism

When short sellers went to cover their position, they were trapped with low liquidity and were not able to buy back the shares. This forced them to deliver the shares the next day according to the T+1 mechanism. However, as short sellers failed to deliver the shares due to the limited publicly available quantity, this led to the auctioning of shares. When the short sellers fail to deliver the obligated quantity, the exchange has to intervene to arrange shares for the original buyers of the shares.

In Groww’s case, shareholders who hold Groww’s shares can offer their shares in the auction and can demand a premium for offering their shares. The original short sellers, who had defaulted on shares, had to bear additional losses by paying a premium and additional penalty to the exchange.