Auction Process – How to Profit from Auction Market

Key Takeaways:

• An auction process is a mechanism where exchange auctions the investor’s stock holding when the person had sold the stock but is unable to deliver it within a stipulated time period.
• An auction can be a live auction, online auction or sealed bid auction.
• Before the start of an auction, the buyers are allowed to check the items on sale and examine the same.
• The minimum or lowest auction price will be 20% below the closing price of the day before the day of the auction
• The exchange conducts an auction on T+2 day and on behalf of the defaulting seller, it purchases back the stock from the Auction Participant.

What is Auction Market?

An auction process is a mechanism where the exchange auctions the investor’s stock holding when the person had sold the stock but is unable to deliver it within a stipulated time period. This mechanism is basically a kind of penalty apart from the fees for the auction. Hence, keep a precaution that your stock doesn’t go into the auction process. It takes place mostly due to an investor’s carelessness.

Whenever you sell shares, there’s always a buyer on the other side. So when you sell shares and cannot deliver it back to the buyer for which he had already paid money,  in such a scenario, the exchange calls for an auction. So your broker will try to purchase the shares in a buy-in auction market on T+2 day and the settlement of auction shall be done on T+3 day (holidays are not included).

In case of a successful auction, the client in default (i.e. you) will have to pay the actual auction price + Brokerage + Penalty (this depends on your broker).

Types of Auction:

1. Live Auction:

Also known as the live on-site auction, this type of auction is conducted in a meeting facility or room like a hotel convention facility.

The interested bidders have already inspected the goods that are being auctioned.

Pictures, as well as the descriptions of the items on sale, are displayed when the bidding process is officially opened.

2. Online Auction:

During online auctions, bidders compete on a particular product and then submit their bids online, over the internet.

Internet auctions haven now become an integral part of electronic commerce due to the flexibility and possibilities they provide.

3. Sealed Bid Auction:

This type of auction is used where there are confidential bids. If the seller is considering optional terms of sale, then sealed auctions are usually chosen.

Working of Auction:

Before the start of an auction, the buyers are allowed to check the items on sale and examine them same.

After the potential buyers have viewed all the items and are interested in placing their bids, they must first register with the auctioneer.

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This registration process requires buyer’s details like phone number, address, and identification like a passport.

Each registered bidder is given a bidder card which has a number used to identify all participants.

The auctioneer gives a description of the item for sale and starts the bidding with a price.

Then, the bidders then call out their bids, with each bid being higher than the last one.

The process finishes when there are no more bids, and the buyer who makes the highest bid gets the item. The highest bidder takes ownership of the item after paying their bid price.

What is Auction Pricing?

The auction pricing depends on the stock price calculation on the auction day. The minimum or lowest auction price will be 20% below the closing price of the day before the day of the auction. Suppose if it is lower, you might gain but this difference goes to the Investor Protection Fund (IPF) and it is not given to you (some broker may pass the gain to you). But say if it is higher, you need to pay the difference.

The closeout on the auction day (i.e. T+2 day) will basically be the highest price prevailing in the market till the auction day from the day of trading or 20% above the closing price on the auction day (whichever is higher).

If the auction is not successful, no one is ready to sell in the auction (generally happens when the stock hits the upper circuit), the sale transaction is canceled by the exchange and the defaulting member has to pay the highest price prevailing from the day of trading (T) up to a day prior to the auction day OR 20% above the official closing price on the day prior to auction day, whichever is higher. The buyer of those shares gets a full refund.

Auction Timing and Participants

The auction process is conducted between 2-2:45 pm on a daily basis. It can be participated only by the member broker of the exchange and sell shares that are short delivered.

Example

Let’s understand the concept of the auction with the help of a practical example.

On Monday, Bittu short sold 1 share of Apollo Hospitals @ Rs 1080.

On Wednesday (i.e. T+2 day), on behalf of Bittu, his broker is required to deliver the stock to the exchange. Say he defaults on delivery.

On this day, the exchange notices that these shares had not been delivered by the broker and it accordingly blocks a sum of money from the broker’s account which is termed as Valuation Debit.

The share valuation price for securities that were not delivered on the settlement day is the closing price of such securities on the immediate trading day (T+1) preceding the pay-in day. Assuming the closing price of Apollo Hospital on T+1 day stands at Rs 1090, the exchange will block the sum equal to Rs 1090 from the broker’s account.

The exchange conducts an auction on T+2 day and on behalf of the defaulting seller, it purchases back the stock from the Auction Participant.

The exchange actually delivers the shares back to the actual buyer back on T+3.

Say the stock was bought back in the auction market at Rs 1110. In that case, an additional sum of Rs 20 will be blocked by the exchange (which is the difference between the Auction purchase price @ Rs 1110 and the Valuation Debit of Rs 1090).

However, if the stock would have been purchased in the auction market at Rs 930, so the difference amount (i.e. Rs 1090-930) will be transferred to the Investor Protection Fund (IPF).

But in case, there isn’t any seller in the auction market, the exchange conducts the closeout in the following manner.

Closeout will be at the highest price prevailing in the NSE from the day of trading till the auction day or 20% above the official closing price on the auction day, whichever is higher.

Now suppose, the highest price from the day of trading to the auction day stands at Rs 1120. Say the closing price on T+2 day (i.e. auction day) was Rs 1110. So the closeout will be higher of Rs 1120 or Rs 1332 (1110 *120%) i.e. Rs 1332 (closeout price). In this case, the additional sum of Rs 42 will be blocked by the exchange.

Can a client profit from this auction process?

Suppose on T+1 day, the closing price of Apollo Hospital was Rs 1040 (This is the valuation debit; which is the Closing Price of the share not delivered on T+1 day x No. of shares not delivered.).

Say the exchange bought back the share from the auction market at Rs 1060. So presently, Rs 1060 will be debited from the broker’s account and the difference of Rs 20 (The price at which you sold i.e. Rs 1080, and the price you bought back in the auction market i.e. Rs 1060) will be your profit. But this profit in most cases is transferred to the Investor Protection Fund (IPF).

A way to avoid the problem of an auction can be online trading.

When you make all the deals yourself without depending on the broker, it will be easier for you to track the stocks you bought and the stocks you hold. You will be able to track your portfolio through a best trading app or portal and thus an effective way to avoid the auction of your stocks.

Actually, an auction process is an effective process from the buyer’s point of view. In fact, an auction process is done to provide the buyers with the stocks which they have purchased from a seller.

Happy Learning !