What is short delivery and what are its consequences?
Short delivery occurs when a seller fails to deliver the promised shares
to the buyer within the stipulated time frame. This situation can arise for
various reasons, such as the seller mistakenly selling shares they do not
possess or due to the illiquidity of the stock.
Key
Points:
- Identification
and Notification:
- On T+1 day (one day after the
transaction), the exchange identifies short deliveries.
- Both buyers and sellers are
notified about the short delivery.
Consequences
of Short Delivery:
- Auction
Process:
- To resolve the short delivery,
the exchange conducts an auction to purchase the missing shares.
- The shares are bought from the
open market, and the defaulting seller is required to cover any price
difference.
- Auction Penalty:
- The defaulting seller may face a
penalty for failing to deliver the shares. This penalty is usually a
percentage of the shortfall value and is meant to compensate the buyer
and the exchange for the inconvenience.
- Delayed Settlement:
- The buyer receives the shares
with a delay due to the time taken to complete the auction process.
- This delay can result in missed
opportunities or potential losses if the stock price fluctuates
unfavorably during the delay.
- Financial Liability:
- The seller is financially liable
for any difference in the price paid during the auction and the original
sale price. If the auction price is higher than the original sale price,
the seller must pay the difference.
- Additionally, the seller may
incur other charges and penalties as determined by the exchange.
- Reputation Damage:
- Frequent short deliveries can
damage the seller's reputation with the brokerage and the exchange.
- It may lead to stricter trading
conditions or increased scrutiny of the seller’s future transactions.
Example
Scenario:
- If a seller
promises to deliver 100 shares of Company XYZ but fails to do so, the
exchange will identify this shortfall on T+1 day.
- An auction will be conducted to
procure the 100 shares, possibly at a higher price.
- The seller will be penalized and
required to cover any price difference, resulting in financial and
reputational consequences.
Understanding short delivery and its consequences helps
both buyers and sellers navigate the complexities of stock trading and avoid
potential pitfalls.
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