By taking positions against overvalued stocks, short sellers inject a dose of realism into the market. In doing so, they help prevent bubbles from inflating unchecked
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Moment Makers Group
India’s equity markets have matured rapidly over the last decade — record demat account growth, thriving retail participation and record-setting trading volumes. But one key piece remains conspicuously underdeveloped: short selling.
While India formally permits short selling and has had a securities lending and borrowing scheme (SLBS) in place for close to two decades, both remain marginal in practice. As regulators review the framework afresh — spurred in part by recent high-profile corporate episodes, it’s worth asking: Why is short selling still so hard in India, and how do we fix it?
India’s cautious model
Unlike some global markets, India allows only covered short selling. Naked shorting — selling shares you neither own nor have borrowed — is banned. Retail and institutional investors alike may short only F&O-listed stocks, a group that currently numbers around 224. For anything beyond this narrow universe, shorting is effectively impossible. Moreover, India requires all short sellers to deliver shares by the T+1 settlement, failing which there are strict penalties, including auction buy-ins and financial costs. Stock lending and borrowing is enabled via the SLB platform run by clearing corporations of exchanges. Short sellers must pre-arrange a borrow through this system or cover intra-day.
This model — designed to protect market integrity — has effectively neutered short selling as a functional strategy in India.
How the world does it
Contrast this with the US, where short selling is widespread. While naked shorting is banned there too, a “locate” requirement allows brokers to sell short as long as they can identify a borrowable pool of shares. This is enabled by a vast, decentralised securities lending market, with trillions of dollars worth of shares on loan. Almost all listed stocks can be shorted. Short interest in the US regularly hovers around 2-3 per cent of market cap in many stocks, and the short interest in S&P 500 stocks alone crossed $800 billion in 2024.
In Europe and the UK, most stocks are shortable, and regulators instead impose post-trade disclosures. Investors holding short positions of 0.5 per cent or more must publicly report them. Japan, Hong Kong and Singapore have similar systems — some requiring short sellers to borrow before trading, others relying on settlement enforcement and buy-in mechanisms.
In short, global peers view short selling as a legitimate and necessary part of market functioning, balancing it through transparency and compliance rather than pre-emptive restrictions.
India’s SLB market
India’s SLB scheme was built with all the right ingredients: CCP-backed settlement, margin requirements, contract standardisation and retail access. But in practice, it remains underused. Despite a list of about 224 eligible stocks and a market capitalisation of over ₹30 trillion, SLB volumes are negligible. Only a fraction of eligible shares is ever lent. Many brokers still haven’t fully integrated SLB into their online systems, leaving the process paper-heavy and inaccessible to most investors.
The result? Even when traders want to short stocks, borrowing shares is difficult, expensive, and opaque.
The derivatives workaround
Unable to short stocks directly, Indian traders rely heavily on single-stock futures and options. NSE’s derivatives market is now the largest in the world by volume — driven not by hedging alone, but also because futures are the only practical way to short.
This workaround has created a peculiar dynamic: India’s derivatives markets are world-class, but its underlying spot market lacks depth on the short side. The challenge is that this activity is also constrained, as the universe of eligible securities for both derivatives and SLB is largely overlapping and limited to just over 200 stocks.
Why short selling matters
Short sellers are often misunderstood, even vilified, but they perform a critical role in the financial ecosystem. In a market where long-only sentiment dominates, short sellers provide essential counterbalance. They question valuations, challenge optimistic narratives and probe the gaps between perception and reality. Their actions contribute directly to price discovery — ensuring that market prices reflect not just exuberance but also scepticism.
This function becomes even more important during periods of speculative excess, when asset prices are buoyed more by sentiment than fundamentals. By taking positions against overvalued stocks, short sellers inject a dose of realism into the market. In doing so, they help prevent bubbles from inflating unchecked.
At a systemic level, this contributes to market stability, not volatility — contrary to popular belief.
Short sellers also add liquidity by increasing trading volume and depth, particularly in downturns when long-side demand may be weak. Their presence facilitates smoother execution for other participants.
Importantly, short selling has historically played a role in uncovering fraud, mis-governance or unsustainable business models.
What needs to change
To unlock the full potential of short selling in India, regulators and market participants must pursue a few key reforms:
Expand the shortable universe: Allow all stocks (excluding stocks in trade-to-trade segments or under special surveillance programmes) to be shorted, subject to delivery enforcement.
Modernise the SLB market: Mandate seamless integration of SLBS into all broker platforms. Make borrowing as easy as placing a trade. Clarify tax treatment of SLB income to encourage retail and institutional lending.
Make SLB real-time and flexible: Introduce same-day lending and borrowing, increase tenure options and simplify collateral norms for borrowers.
Improve transparency: Publish daily short interest data by stock. Avoid over-disclosure that could lead to squeeze attempts but ensure visibility for the broader market.
Support through clearing corporations: Allow CCPs to auto-borrow shares on behalf of short sellers at settlement, minimising naked short risks without killing trades at inception.
The way forward
India’s equity market is a major global asset class. But if we want efficient and resilient markets, we must stop treating short selling as suspect and start treating it as essential. If SEBI can strike the right balance — between flexibility and oversight, between investor protection and price discovery — India could finally build a robust, fair and globally aligned short selling ecosystem. Let the shorts in — not just because markets need critics, but because they make the system stronger.
The writer is Founding Partner, SPRV Consultants
Published on September 4, 2025