What Trades to take if you are Bearish — Part1

Bearish means we expect the prices to go down. Ideally, we should be able to sell the shares first and then buy them back at a lower price to make money. This concept is called short selling. However, it is not practical to sell something that you do not have, hence a concept of SLBM applies.

Stock Lending and Borrowing Mechanism (SLBM) — A trader can borrow the shares from a lender for a fixed interest rate and then sell them. The lender gets an interest income when he lends his shares to a borrower. And the borrower can participate by selling the shares even though he does not own them.

Let us understand it with an example. ICICI Bank is currently at Rs1080. PersonA wishes to sell 5000 qty of ICICI Bank but he does not have enough holdings in his portfolio.

He contacts the broker and under the SLBM facility gets 5000 qty from PersonB. The lender here is PersonB who might have agreed to transfer the aforesaid qty for an interest of say 15% (1 year).

PersonA goes ahead and short sells the 5000 qty of ICICI Bank.

Case1: The value of ICICI Bank goes to Rs1000. If PersonA decides to close his trade he nets a premium of Rs80 (1080–1000). Once PersonA squares off his trade, the borrowed shares are assigned back to the lender. The lender gets back his shares and an interest component for the period.

Case2: The value of ICICI Bank goes to Rs1200. If PersonA squares off his position now, he stands to lose Rs120 (1200–1080). This amount has to be settled by the borrower. The lender gets his shares back and also an interest component.

Case3: The value of ICICI Bank stays as it is. PersonA squares off his position for a no loss/no profit price. PersonB gets his shares back with an interest component.

SLBM although seems intuitive, it is not that easy to execute. A better way to participate in the downward move of a stock is via options trading. We could deploy a strategy called Bear Put Spread. We will discuss that in detail tomorrow.

Book a free consultation — Get your mutual fund holdings audited based on your risk profile — https://learn.viswaram.com/knowmore