What happens when there’s a short delivery of shares and the exchange finds no fresh sellers in the auction markets?
When there’s a short delivery of shares and the exchange finds no fresh sellers in the auction markets, they are deemed closed out. The exchanges instead of delivering the shares to the buyer make the settlement in cash, on the basis of close out rate.
Close out rate will be at the highest price in the exchange from the day of trading till the auction day for the stock which was short delivered or 20% above the official closing price on the auction day, whichever is higher. This then gets passed on to the buyer. Think of it as compensation to the buyer for the non-delivery of shares.
For Example -
Assume you bought 100 shares of ITC at Rs. 700/- per share, and these shares were short delivered, as a result of which you don’t receive delivery on T+2. The Exchange then carries out an Auction from where it tries to find fresh sellers who can deliver 100 shares of ITC to be ultimately delivered to you. If there are no fresh sellers in the auction markets, the trade gets settled by way of a close-out.
Assume, the official closing price of ITC on the auction date (T+2) was Rs. 800/-. In this case, the Exchange would close out the trade at Rs.960/- (20% higher than 800), and the seller of the stock who defaulted will have to bear the auction penalty of Rs.16,000/- (960-800*100). So the buyer would receive Rs 96,000/- (Rs 80,000, i.e. the closing price on the auction date + Rs 16,000 as the auction penalty) in total.
However, if the price of ITC had reached 980 (from the day of trading till the auction day) then the close out is done at Rs. 980 and not at Rs. 960 since it is higher than the closing price + 20% auction penalty of ITC on the auction date. In such a case, the buyer of the securities would be compensated with a credit of Rs.980 per share.
To know more about short delivery and its consequences, click here.