How Auction Affects My Portfolio and Profit And Loss

How Auction Affects My Portfolio and Profit And Loss

Exploring the world of trading can be both captivating and overwhelming. As investors, it's crucial to grasp the inner workings of various trading practices. One such practice that warrants attention is BTST (Buy Today Sell Tomorrow) trading.

What are BTST Trades?

In the Indian stock market, trades are typically settled on a T+1 basis, meaning that the settlement occurs one trading day after the transaction. This brings us to an intriguing trading approach known as BTST, or "Buy Today Sell Tomorrow." With BTST trades, investors have the opportunity to buy and sell shares on the very next trading day.

For example, if you buy Reliance Industries Ltd. (RIL) shares today, they will be credited to your demat account tomorrow. Similarly, selling RIL shares today ensures that the proceeds will be in your bank account tomorrow.

This swift turnaround time in buying and selling shares offers traders a chance to seize potential opportunities and take advantage of market movements without having to wait for an extended settlement period.

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What is the Auction Risk of BTST Trades?

In BTST trading, a trader sells shares that are not yet available in their demat account. The entire process hinges on the seller from whom you made the purchase.

However, there is a potential risk involved. If the seller fails to fulfil their commitment to delivering the shares you bought from them, it leads to what is known as a short delivery, and you may find yourself liable for an auction penalty. This penalty serves as a consequence of the shortfall in the delivery of shares and can be as high as 20% of the undelivered stock's value.

Let’s explore the inherent risk of auctioning in BTST trades with the help of an example.

Suppose you bought 10 RIL stocks on Monday and sold them on Tuesday, which is also the settlement date. However, the seller fails to deliver the purchased shares. Subsequently, you will default on your sell transaction on Wednesday (T+1 settlement for Tuesday's trade). While you will receive auction credit for your transaction on Monday, you will also incur an auction penalty for the default on Tuesday's sell transaction.

Extent of the Auction Rate Penalty

In BTST trades, you may face an auction penalty in two scenarios. Let's delve into these situations and understand how the auction penalty rate is calculated.

1. Internal Auction

This is how the penalty is calculated when an internal auction is concerned:

  1. (The closing price of the RIL share on T+2) + 7%, or
  2. The highest-price the share is traded between T & T+1, or
  3. Whichever of the above options is higher

2. Market Auction

In the case of a market auction, it is the stock exchange that calculates the valuation price for determining the auction portfolio. The calculation:

  1. The highest-price the share is traded between T-day & T+1-day, or
  2. The closing price of official auction marketing on T+2 settlement day + 20%
  3. Whichever of the above two options is higher

As a thumb-rule, Motilal Oswal first uses the internal auction for levying an auction rate penalty. The balance is sent to the market for auction only after the internal auction. 

How Does the Auction Rate Penalty Impact Your Portfolio or Profit & Loss?

Let's see how the auction rate penalty affects your portfolio or profit & loss with an example.

Suppose you sell 10 RIL shares at Rs. 2,500 each on Monday, with no available sellers due to the stock hitting the upper circuit. On Tuesday, the stock exchange conducts an auction using Monday's closing price of Rs. 3,000. The auction price range is Rs. 2,400 to Rs. 3,600.

If the auction price on Wednesday is Rs. 3,200, the seller would pay a penalty of Rs. 7,000 ([Auction Price - Sell Price] x No. of Shares).

When you are calculating the impact on your portfolio or profit and loss, two entries will be created with the auction-valuation-price:

  • For the buyer: Sell entry
  • For the seller: Buy entry

This means that the seller will incur a loss of Rs. 7,000, and the buyer will make a profit of Rs. 7,000.

How to Avoid an Auction Penalty?

Trading in highly liquid stocks, such as blue-chip or group-A stocks, is a prudent strategy to steer clear of auction penalties. These stocks are characterized by robust market demand and trading activity, reducing the risk of encountering delivery issues and associated penalties.

The Takeaway

Understanding auctioning in BTST trades is crucial for investors. The risks of short delivery and auction penalties highlight the need for due diligence and trading in liquid stocks. Informed decisions empower investors to navigate BTST trading confidently.

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