Hit by a short-seller’s research report, Adani lost $7bn in a day: Short-selling explained
Billionaire Gautam Adani’s personal wealth saw erosion on Wednesday, January 25, after the conglomerate’s shares fell by up to 10% during the day following a negative report by American short-selling firm Hindenburg Research. The 60-year-old businessman’s wealth dropped by $7 billion to reach $119.5 billion on Wednesday, according to reports quoting Forbes Millionaires List.
Shares of all 10 Adani Group stocks tanked after Hindenburg revealed that it has been short-selling Adani Group companies through US-traded bonds and non-Indian-traded derivative instruments. The investment research firm has accused Adani Group companies of stock manipulation, accounting fraud, and financial irregularities over the course of decades. Key listed Adani companies have taken on substantial debt, including pledging shares of their inflated stock for loans, putting the entire group on a precarious financial footing, the Hindenburg report said.
What is short-selling?
While many successful traders profit from stocks that rise in value, some profit from stocks that decline in value through a strategy known as short selling. Short selling involves borrowing a security from a brokerage firm on speculation that its price is going to fall and selling it in the open market. The plan is to then buy the same stock back later, hopefully at a lower price than what it was initially sold for, and pocketing the difference after repaying the initial loan.
For example, if a stock is trading at Rs 40 a share, you decide to borrow 100 shares and sell them for Rs 4,000. The price then suddenly falls to Rs 20 a share, at which point you purchase 100 shares to replace those you borrowed, netting a profit of Rs 2,000.
Since you are borrowing shares from a brokerage firm, you have to first set up a margin account to hold eligible bonds, cash, mutual funds, and/or stocks as collateral. As with other forms of borrowing, you will be charged interest on the value of the outstanding shares until they're returned. Once you have opened and funded your margin account, you can begin researching possible short-sale candidates.
What are the risks involved?
Short-selling can lead to potentially limitless losses since the price of a stock can keep rising infinitely. In theory, this means there's no upper limit to the amount you would have to pay to replace the borrowed shares. For example, you enter a short position on 100 shares of stock ABC at Rs 70, but instead of falling, the stock rises to Rs 100. You will have to spend Rs 10,000 to pay back your borrowed shares, at a loss of Rs 3,000.
The cost to borrow a stock can change frequently in response to demand-supply conditions. For example, a short position carrying a 20% interest rate can surge to 80% the next day. Further, if the value of the stock that’s shorted and the accompanying interest rate both rise at the same time, this can make the situation worse.
Moreover, short sellers aren’t entitled to dividend payments from the shares they have borrowed. The value of any dividends paid will be deducted from the short-seller's account on the pay date and delivered to the stock's owner.