Why short selling may be good for investors

**SPEAKER_1** (0:00)
Hello folks, you're tuned in Finshots Daily. In today's episode, we explain why SEBI is planning to make short selling easier in Indian markets.
But before we begin, here's a quick note from team Ditto. This weekend, we're hosting a free two-day insurance masterclass that helps you build real financial security by understanding health and life insurance the right way. Well, the masterclass is completely free, and you can head to the link in the description to register while you see it's last.
Okay, let's start with the story.
Short sellers are like smoke detectors. Most people only appreciate them after something has gone terribly wrong. That's because they're usually the first one to point out when something isn't right. Maybe a company's finances don't add up. Maybe its valuation has become absurd, or maybe investors have simply become too optimistic.
By betting against stocks, short sellers force markets to confront uncomfortable questions long before everyone else does. And for decades, India has kept short sellers on a pretty short leash. However, according to a recent report, SEBI may finally be loosening the rules. According to a report, SEBI is considering doubling the number of stocks eligible for short selling, along with making it easy for investors to short stocks. Which isn't a little surprising.
After all, why would any regulator make it easier for people to bet against companies? When that simply invite more speculation, panic and market crashes? Well, not necessarily. In fact, many market veterans argue that restricting short sellers can create a very different problem. When everyone can easily bet that prices will rise, but very few can conveniently bet they'll fall, markets can become one sided. Optimism faces little resistance, and prices don't always reflect reality. That's exactly the point Zerodha founder, Nathan Cometh made last year. He argued that India's market has become tilted toward long-only investing. That's not because investors don't hold negative views, but because expressing those views through short selling remains cumbersome. Economists call this price discovery, the process by which markets figure out what a stock is truly worth. That only works when both optimistic and pessimistic views can compete on equal footing. If one side is much harder to express than the other, prices can drift away from reality. To understand why, it helps to know how short selling actually works. Imagine you believe shares of company X currently trading at about 1000 rupees are wildly overpriced. If you simply avoid buying the stock, you don't make any money if you're right. So instead, you borrow one share from another investor and immediately sell it in the market for 1000 rupees. A few weeks later, suppose the stock falls to 800 rupees, you buy back the same share for 800 and return it to the original owner. You pocket the 200 rupees difference minus borrowing costs and other charges. Now that is short selling in its simplest form. Of course, there's a catch. If the stock rises instead of falling, you still have to buy it back to return the borrowed share, except now you're buying it at a higher price. Like a regular investor whose maximum loss is limited to the money invested. A short seller's losses can theoretically keep growing as the stock price climbs. So if short sellers help market function better, why has India never fully embraced them? Part of the answer lies in the history. During the 2008 global financial crisis, governments across the world temporarily banned or restricted short selling, firm in the belief that it was accelerating the collapse of stocks. Regulators feared that bearish bets could turn panic into a full blown crash. Interestingly though, latest studies found little evidence that these bans actually helped calm markets, but by then the damage to short sellers' reputation was already done.
However, India wasn't exactly eager to roll out the red carpet either. Sure, short selling was eventually allowed, but it came with plenty of caveats. First, you had to find someone willing to lend you the shares. Then, hope that the stock was even eligible under the SLB mechanism, that's Securities Lending and Borrowing Mechanism.
And of course, you'd have to pay for the privilege of borrowing those shares in the first place. In other words, betting for a stock was easy, betting against one came with a lot more homework. So, what did traders do instead? Well, if they believed the stock was going to fall, they simply took a different route. One that was faster, simpler and already sitting right in front of them. Futures and Options Traders could either sell call options or buy put options. Selling a call option is essentially a bet that a stock won't rise much. If the price stays below a certain level, the seller pockets the premium. Buying a put option, on the other hand, gives traders the right to sell a stock at a fixed price in the future, making it more valuable when the stock price falls. In both cases, traders can profit from falling prices without ever borrowing or selling the actual shares. Today, India's equity derivative segment sees an average daily turnover of nearly 2.64 lakh crores, while the cash market records around 1.21 lakh crores. In other words, the easier route has become the busier one. Of course, bigger participation didn't necessarily translate into better outcomes. Between FY22 and 24, 93% of individual F&O traders lost money, collectively wiping out more than 1.8 lakh crores. In FY24 alone, over 91% of retail traders ended up in the red. Now, to be clear, we're not saying these losses happened because short selling in the cash market was difficult. Markets usually aren't that simple. But if betting against a stock in the cash market feels like navigating an obstacle course, it's not surprising that many traders move towards derivatives instead. And that's what makes SEBI's step so interesting. It is constantly doubling the number of stocks that can be borrowed through the SLB mechanism while also lowering collateral requirements. Today, only about 176 stocks are eligible. That's barely a fraction of the thousands listed on Indian exchanges.