Exploring buy in: What it means and why it matters

In the stock market, each party is bound by some obligations. For example, if you acquire shares in the secondary market, the seller must deliver the securities on the settlement day. The delivery is handled by the broker with whom the seller has a Demat account. But have you ever thought what would happen if the broker fails to deliver? Well, the concept of buy in comes up here. 

What is buy in trading?

A buy in for stocks occurs when a trader is compelled to repurchase shares because the seller failed to deliver the original shares as agreed upon. This situation arises in the context of short selling. A trader borrows shares to sell them and then repurchases them later at a lower price. 

If the seller cannot deliver the shares, the buyer may issue a buy in notice, prompting the stock exchange to facilitate the repurchase of the shares from another seller.

Let’s consider you are a trader who decides to short-sell 100 shares of XYZ Ltd at Rs 500 per share, expecting the price to drop. However, the price has increased to Rs 550 instead. 

The initial seller declined to deliver the shares to you, so you now face a potential loss. To mitigate this, a buy in is initiated, and the shares are repurchased at the current market price of Rs 550.

However, depending upon the scenario, you might be responsible for the price difference, amounting to Rs 5,000 (Rs 550 – Rs 500 x 100 shares).

Settlement Process in India

The National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) handle buy in stock auctions in India. If there is a delivery failure, the exchanges conduct an auction on the T+2 day to procure the undelivered shares. 

Traders and brokers can participate in this auction by submitting bids for the short position. The settlement of buy in stocks takes place in T+3 days. 

If the price increases between the original and repurchase transaction date, the selling party is required to bear the cost difference to compensate the buyer.

It is possible that the stock’s market price will fall after the initial transaction date. When the buy in price is less than the initial transaction price, the buyer has to pay the price difference to compensate the seller.

Factors affecting buy ins

Since we have discussed buy ins from the traders’ perspective, let’s consider the factors that influence buy ins from the broker’s perspective.

1. Lack of Liquidity

In the stock market, if a stock doesn’t trade often (low liquidity), the price to buy (ask) and the price to sell (bid) can be far apart. This is called a wide bid-ask spread. So, when you want to buy shares, you might have to pay more; when you want to sell, you might get less money. This scenario is usually common with small-cap stocks.

In this situation, the broker requires the short seller to close out their position and return the shares they had borrowed.

2. High short interest

High short interest indicates that many traders have borrowed shares to sell them. It implies that traders are betting the price will drop, leading to a quick drying up of shares available for borrowing.

It is essential to mention that stocks with a high short interest suggest a lot of negative sentiment about their future price. 

3. Brokers’ discretion

Brokers’ discretion comes into play when they can make decisions like initiating a buy in without needing the trader’s approval for each action. Brokers are given this discretion to protect their interests and ensure that trades are correctly settled. 

If a broker perceives a high risk in a short sale transaction—maybe the market is volatile, or the shares are hard to come by—they can decide to call in buy in to mitigate potential losses.

4. Short squeeze

This financial phenomenon occurs when a stock with a high degree of short interest increases in price. This ultimately prompts short sellers to buy shares to cover their positions and limit losses. 

The buying pressure creates a feedback loop that drives the price up further. This could be due to unexpected positive news, a change in market sentiment, or other factors.

5. Corporate actions

Corporate actions are decisions a company’s management makes that often have significant implications for its stock and shareholders. These include dividends, stock splits, mergers, acquisitions, and buy-backs. The effect of corporate actions on stock buy in can be multifaceted and depends on the nature of the action.

For example, in the case of mergers and acquisitions, if the market perceives the action as disadvantageous, it can lead to a negative reaction and compel brokers to call in a short position for risk mitigation.

6. Volatility 

In a volatile market, stock prices can swing significantly in either direction, affecting trader behaviour and strategy. High volatility often indicates uncertainty in the market, which can contribute to unusual risk for traders as the stock prices are less predictable. 

This unpredictability can deter some traders from buying in, as they may prefer stability and predictability in their investments. On the other hand, brokers will go for buy in in such situations for obvious reasons.

Conclusion

Understanding buy in is crucial in the stock market. This term discusses the scenario when one party can’t deliver shares they have promised to sell. This usually occurs in short selling. If the seller doesn’t fulfill their obligation, the buyer can send a buy in notice, asking the exchange to assist in delivering shares from another source. 

This process protects traders from losses due to delivery failures—factors like liquidity, short interest, and market volatility influence buy ins. To know more, read StockGro blogs.

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