In the auction session, the Exchange invites offers from fresh sellers for quantities short delivered (10 shares of Titan in the below example)
Exchange ensures that if you buy shares, you get credit for the shares. Now, assume Client A bought 10 shares of Titan from Client B and Client B doesn’t authorize these shares on CDSL, then the Exchange will treat this as an ‘Short Delivery’ on T+2.
Now what happens is that the Exchange conducts an Auction and buys these shares for Client A in the Auction market and gives delivery of these shares to Client A on T+3 instead of T+2.
Note: In the case of physical settlement of derivatives, if the seller defaults on the delivery, the exchange conducts an auction on T+3 days. In such a case, the settlement time will be T+4 days.
When does the auction happen and who can participate in the auction market?
It is a special market where only members of the Exchange can participate as fresh sellers and sell shares which are short delivered. The auction market is conducted every day between 2:00 PM and 2:45 PM. To ensure that there is no conflict of interest, the Exchange doesn’t allow the member whose client has defaulted in delivering to take part in the auction market.
At what price are the shares sold?
There is no fixed price for the auction to happen. The Exchange specifies a range within which the auction participants can offer to sell their shares.
Upper cap of the range: 20% higher than the price that it closed on the previous day of the auction (T+2 day of trade). For example, if you sell a stock on Monday, the auction happens on Wednesday with the closing price of Tuesday used to determine the auction price.
Lower cap of the range: 20% lower than the price that it closed on the previous day of the auction. For example, if you sell a stock on Monday, the auction happens on Wednesday with the closing price of Tuesday used to determine the auction price.
Exchange penalty for stocks in Auction
So in the Titan example above, a fresh seller can offer to sell 10 shares of Titan in the auction market in the range of ₹800 (assuming Titan closed at ₹1000 the next day; 20% below 1000) to.₹1200 (20% above 1000).
Assume that Client A bought 100 shares of Titan from Client B at.₹960 and Client B defaulted in giving the shares.
In the auction market suppose the fresh seller is offering to sell 10 shares at ₹1120 only.
The Exchange is obligated to buy it at whatever price and give delivery of these shares to Client A. The Exchange would hence buy these shares at Rs.1120/- and give the shares. Since Client. B has defaulted he would have to pay the difference of ₹(1120-960)*10 = ₹1600/- to the exchange. Along with this, the Exchange also charges an additional penalty of 0.05% of the value of stock per day that Client B failed to deliver. The sum of both the above together is called ‘Auction Penalty’.
Hence, it is very important that you authorize the sell transaction of a stock on CDSL before the stipulated time or you could end up paying a considerable amount of money as ‘Auction Penalty’.
Note: Same is applicable for T+1 settlement.