It is argued that there is an imbalance in the carryforward system as "it gives a huge incentive to short sellers for speculation while it penalises long buyers for the same act, that is speculation". It is suggested that the short sellers, too, be required to pay charges for speculative selling so as to remove the imbalance between the bulls and bears. Both the short seller and the long buyer would then be paying equal charges for speculation and the short sellers would not be unduly benefited.

The facility to carryforward the transaction necessarily means that the carryforward has to be at a price to be paid either by the buyer or the seller and not both and this price depends upon a constantly varying set of factors like the extent of outstanding positions, floating stock,returns available in alternative channels of investment, ready availability of finance, extent of short sale, etc.

In the carryforward system, it often happens that while the purchaser wants to carryforward his purchase position, the seller would like to give delivery of the shares. It is in this context that a badla financier who does badla from the point of view of earning interest on his finance enters the stock market. He purchases in the current settlement from the purchaser who does not want to take delivery but wants to carryforward his purchase to the next settlement, and sells the same shares to that purchaser in the next settlement, thus taking delivery of the shares in the current settlement from the seller on behalf of such a purchaser. The difference between the purchase price in the current settlement and the sale price in the next settlement is the interest earned by the financier. This is known as contango, or `seedha badla' or `vyaj badla'.

Contango charges are indicative of a normalmarket situation. Payment of contango charges is made by the buyer to the seller in lieu of the payment the buyer would otherwise be required to pay to the seller for the purchases effected by him. A buyer who is not able to pay for the shares purchased by him has necessarily to pay interest on the amount of money required for such purchases.

While `vyaj badla' is obviously done for interest and as such interest has to be paid by the buyer to the `badliwala' who has become a seller in the ensuing settlement, but for which the `badliwala' would not enter the stock market, the question that needs to be explained is the interest that is paid to the short seller. It needs to be noted that once a contract is struck between a buyer and a seller, the rights and obligations relating to the contract are fixed, irrespective of whether the seller has shares or not.

A long buyer who does not want to take delivery against a genuine seller who wants to give delivery has a saviour in the `badliwala' as finance isreadily available for a consideration. The short seller who does not want to give delivery can, however, virtually be held to ransom by the buyer who insists on taking delivery. The short seller has then either to borrow the stocks which is not easy as stocks unlike money are not readily available, or to pay interest, technically called backwardation charges to the buyer.This is precisely why backwardation charges can and do shoot to abnormal levels occasionally.

It is open to a financially strong bull even to refuse to carryforward the transaction by receipt of backwardation charges but to insist on delivery in which case auctions take place automatically and the difference in the price between the auction rates and the contract rates has to be paid by the defaulting seller.

Badla rates, whether contango or backwardation, are fixed by the market forces and as such vary from settlement to settlement, from one scrip to another scrip in the same settlement and in the same scrip in the same settlement in thebadla session.

Unlike the badla financier who can dictate his terms and charge a much higher rate of interest Continued from Page 9from the buyer, it is the short seller who imparts sobriety to the level of interest rate in the market and contrary to the general belief, larger the component of short sale, lower is the rate of contango charge.

To illustrate this point, let us say there is a total outstanding position of say 200,000 shares in Tisco out of which sellers have say 150,000 shares ready for delivery and buyers are prepared to take delivery of 100,000 shares. An outstanding position of 100,000 sales and purchases get automatically adjusted between willing sellers and willing buyers desiring to give delivery and take delivery. The balance 50,000 shares available for delivery get apportioned among the `badliwalas'. The rate of contango shares is determined by the `badliwalas' (who purchase 50,000 shares in the current settlement and sell 50,000 shares in the ensuing settlement) and the shortsellers of 50,000 shares on the one hand and the long purchasers of 100,000 shares on the other hand. While a situation of this type may result in a contango charge of say 18 per cent, any increase in the proportion of short sale vis-a-vis the holdings of `badliwalas' will, ceterus paribus, lead to a contraction in the contango charges and conversely any decrease in the proportion of short sale vis-a-vis the holdings of `badliwalas' will result in an increase in the contango charges.

This issue is, however, not so simplistic as is explained above as factors like availability of shares for actual delivery, extent of shares for actual delivery, extent of shares to be absorbed by the `badliwalas' and extent of short sales are constantly changing factors reacting to an ever-changing dynamic situation. Complicated as the situation is, it becomes more so because each scrip has its own distinctive technical position unrelated to the other scrips. This is precisely why there are a few scrips attractingbackwardation charges in every settlement. The contango charges or the backwardation charges in the same scrip and in the same settlement also vary widely due to the play of the normal market forces of supply and demand during the `badla' session.

The GS Patel Committee, on the basis of whose recommendations the revised carryforward system of trading had commenced in January 1996, had examined the question of payment of contango charges to short sellers and come to the conclusion that "denial of contango charges to the short sellers would virtually drive them out of the market and their absence will lead to malfunctioning and chaotic conditions in the market."

The suggestion made by the dissenters of payment of contango charges to short sellers that both the short seller and the long buyer pay charges is, to say the least, ridiculous. To whom are the charges to be paid? Charges can be paid either by way of contango by the buyer to the seller or by way of backwardation by the seller to buyer. Both cannotpay the charges to a third party. Whether there would be contango charges or backwardation charges is determined by the market forces.

From the foregoing analysis, the conclusion is obvious. A short seller is part and parcel of a forward market in securities and without him the market cannot function in an orderly and systematic way. He is entitled to, in fact, it is he who ensures that the contango charges which a buyer has to pay are contained within reasonable limits. The short seller is the backbone of the market.

(The author is the former executive director of BSE)