Explained: Why are short-sellers getting trapped after the listing of startup IPOs?

Short-sellers in newly listed startup stocks are increasingly finding themselves on the wrong side of the trade, as sharp post-listing rallies, thin supply of shares and India's settlement rules combine to create painful outcomes. The recent cases of Meesho and Groww show how betting against momentum in low free-float IPOs can quickly spiral into forced losses.

How does short-selling work in India?

To understand what is happening, it is important to first look at how short-selling works in India. When a trader shorts a stock, they sell shares they do not own, hoping to buy them back later at a lower price and pocket the difference.


However, Indian markets follow a mandatory delivery-based settlement system. If a seller is unable to deliver shares on settlement day, it results in what is called a short delivery. In such cases, the exchange steps in to complete the trade through a special auction mechanism.

What happened with Meesho and Groww?

This is where problems arise in newly listed IPO stocks. In Meesho's case, the stock has rallied about 110% from its issue price of Rs 111 in just seven trading sessions. The sharp rise has been driven by strong demand and extremely limited supply.

Meesho currently has only about 6% free float, meaning a vast majority of shares are locked in with promoters and early investors who cannot sell due to lock-in rules. With so few shares actually available for trading, prices can move sharply higher even on modest buying interest.

Traders who expected a correction after Meesho's strong debut took short positions. But as prices kept rising and shares remained scarce, many could not buy stock to deliver on settlement day.

As a result, over one crore shares slipped into the exchange auction mechanism. The auction prices are always higher compared to the market prices, worsening losses for trapped short-sellers.

A similar episode played out last month in Groww. The stock surged nearly 89% over its IPO price within days of listing. With a free float of around 7%, Groww saw nearly 30 lakh shares enter the auction market after short sellers failed to deliver. In both cases, low free float amplified price moves and made short-selling particularly risky.

What happens in the auction process for these shares?

In the auction process, which typically runs for 30 minutes after 2:30 pm, the exchange invites fresh sellers to offer shares to settle the shortfall. Only shares already settled in demat accounts can be sold, and traders cannot buy in the auction as the exchange itself is the buyer.

Prices in the auction can go up to 20% above the previous close, and orders cannot be modified once placed. This often forces short sellers to buy shares at steep premiums, locking in losses.

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