What is an Auction Process?

Key Highlights

• An auction market involves competitive bids and offers from buyers and sellers.

• If an investor fails to deliver shares, the exchange holds an auction process to fulfil obligations.

• There are three types of auction: live, online and sealed bid.

• An auction in the Indian stock market is conducted every day by the exchanges between 2:00 p.m. and 2:45 p.m.

What is an Auction in the Share Market?

Auction refers to the process in which the buyers and sellers simultaneously make aggressive bids and offers. The stock exchange shows the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.

A deal takes place when the bid and offer prices are the same. Unlike an over-the-counter (OTC) market where deals are negotiated, this one doesn't. Auctions are also used in initial public offerings (IPOs). IPOs use the Dutch auction method. In the Dutch auction method, the auctioneer begins with a high ask price while selling. Then he continuously reduces the price until a participant accepts it. Globally, many stock exchanges use auctions.

Auction Process in the Stock Market

Before the auction, buyers have the opportunity to check the objects up for bid. After viewing all of the items, potential buyers must register with the auctioneer before placing a bid.

The registration process requires information about the buyers, such as their phone number, address, etc. Each registered bidder receives a bidder card, which contains a number used to identify them. Auctioneers describe the items they are selling before setting a starting bid.

Following that, each bidder makes a greater offer than the one before. After all offers have been submitted, the item is won by the highest bidder. In exchange for their bid amount, the highest bidder receives the item.

Example of Auction in Stock Market

Let's say Mr A sells 100 shares of XYZ company to Mr B for Rs 100. On T+1 day, Mr A fails to deliver the shares to the exchange. Even though Mr A was unable to deliver the shares, Mr B will get them as he has already made the payment. In this case, it is the responsibility of the exchange to deliver the shares by holding an auction.

By using its website or any other medium of communication between the exchange and member brokers, the exchange will notify member brokers about the auctions. In the auction, all interested brokers can participate, and the lowest bidder can sell his shares. The exchange purchases the shares from the bidder and gives them to the buyer (Mr B).

Types of Auction

In general, three types of auctions can be held, depending on the nature of the purchase. They are:

• Live auction: This type of auction takes place in the physical presence of the bidder. This auction can take place at any exchange-specified location where all the bidders meet.
• Online auction: During an online auction, participants compete for a specific item online. Online auctions have now become a fundamental element of electronic trading because of their flexibility and opportunities.
• Sealed bid auction: This type of auction is used when there are secret bids. Sellers typically choose sealed auctions when they are considering optional conditions of sale.

Why are Shares Auctioned?

There are two main reasons why share auctions take place in equity markets. The first scenario is if you sold shares but failed to pay on the delivery date. Different factors can lead to this. They may include discrepancies in delivery slips or shares pledged as collateral or for margin requirements.

The second scenario is when there is a short delivery of shares. It happens when a trader takes a short position on a stock but fails to close the position within the same trading day. To ensure that the transaction is completed, the exchange initiates the auction process.

Who can Participate in the Auction?

Anyone can participate in an auction by contacting their broker for information on upcoming auctions and placing bids through their broker. However, the brokerage firm whose client defaults is not eligible to participate in the auction for the same security. All other members of the exchange are eligible to participate in the auction.

Conclusion

In the Indian stock market, share auctions ensure the completion of transactions in cases of default or short delivery. There is a specific procedure for these auctions, which are regulated by the exchanges, such as the NSE and BSE. The registered brokers are notified about the auction process so that they can participate. As long as investors follow the regulations set by the exchanges, they will have no problem understanding an auction in the stock market and making informed trading decisions. Both buyers and sellers need to understand the auction procedure to ensure the completion of transactions and maintain the integrity of the market.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Please read the SEBI-prescribed Combined Risk Disclosure Document before investing. Brokerage will not exceed SEBI’s prescribed limit.