NISM-Series-VII: Securities Operations and Risk Management · Settlement Process
Shortages, Auctions and Close-out in Securities Settlement
Updated 11 October 2026 · Fact-checked
When a seller fails to deliver securities at pay-in, the shortage is handled through an exchange auction, where the clearing corporation buys the shares for the buyer. If no seller offers them in the auction, the trade is closed out at the higher of two set prices. The defaulting seller bears the extra cost.
Understand Shortages, Auctions and Close-out
A trade settles only when the seller delivers securities and the buyer pays. A shortage arises when a seller (through the clearing member) does not deliver all the securities due at pay-in. The buyer is then short of securities they are owed.
The clearing corporation does not leave the buyer waiting. It first tries an auction. The exchange runs a special auction session in which the short quantity is offered for purchase. Other participants can offer to sell. The clearing corporation buys at the auction and delivers to the buyer. The buyer pays only the original trade price, not the auction price.
The defaulting seller pays for the failure. If the auction price is higher than the price at which they originally sold, they bear the difference. Penalties and charges can also apply. The seller does not gain if the auction price is lower than the original price.
Sometimes the auction fails because no one offers the shares. Then the trade is closed out. It is cancelled at a close-out price, which is the higher of the highest price in the normal market from the trade day to the auction day and 20% above the official closing price on the auction day. The price is deliberately high, so that the seller is discouraged from defaulting. The buyer gets money compensation instead of shares.
Bad delivery means a delivery that is rejected because of defects. It mainly belongs to the physical-share era. Most trading is now in dematerialised form, where delivery is by credit to the buyer's demat account. Treat bad delivery as a definition-type topic: the buyer rejects the defective delivery, and the seller must replace it or it becomes a shortage.
Key formulas to remember
- Close-out price
- Close-out price = higher of (highest price in the normal market from the trade day to the auction day) and (official closing price on the auction day × 1.20)
- This is the exchange rule for close-out. The 20% margin above the closing price is the part students forget.
- Seller's loss in an auction
- Loss = (Auction price − Original sale price) × Short quantity, if auction price is higher
- The buyer pays only the original trade price. The seller bears any excess of the auction price over it. Penalties and charges come on top. If the auction price is lower, the seller does not receive the difference.
- Seller's loss in a close-out
- Difference = (Close-out price − Original sale price) × Short quantity
- This ignores penalties and charges. The buyer is compensated at the close-out price.
- Order of action
- Shortage at pay-in → Auction → Close-out if the auction gets no seller
- Auction comes first. Close-out is the fallback.
How to solve Shortages, Auctions and Close-out questions
Use this order for any question on shortages, auctions or close-out.
- 1Identify the shortage: which securities and how many were not delivered at pay-in.
- 2Check whether the question is about the auction or about close-out. Auction is the first step. Close-out applies only if the auction does not give the securities.
- 3Note who bears the cost. It is always the defaulting seller, not the buyer.
- 4If a price is asked in a close-out, list the two candidates: the highest price from trade day to auction day, and 1.20 × the official closing price on the auction day.
- 5Pick the higher of the two as the close-out price.
- 6For the seller's loss, subtract the original sale price from the auction or close-out price and multiply by the short quantity.
- 7Check the options for traps such as the lower of the two prices, or 20% below the close, and then choose.
Quickest way: Higher of two prices, then multiply
When to use it: Use it for numerical close-out questions in a timed test.
- Compute 1.20 × closing price on the auction day first.
- Compare it with the highest price from trade day to auction day.
- Take the larger number as the close-out price.
- Subtract the original sale price and multiply by the short quantity if asked for the seller's loss.
Common mistakes in Shortages, Auctions and Close-out
Choosing the lower of the two close-out price candidates
Students assume the price should be fair to the seller.
Fix: Remember the close-out price is meant to deter default. Always take the higher value.
Applying 20% below the closing price instead of above
Mixing it up with price band or discount ideas.
Fix: Close-out uses 20% above the official closing price on the auction day.
Treating close-out as the first step
The word sounds final, so students place it first.
Fix: Auction comes first. Close-out happens only if the auction does not produce the securities.
Thinking the buyer bears the extra auction cost
The buyer is the one buying in the auction.
Fix: The defaulting seller bears the cost. The buyer receives the securities or the close-out compensation.
Assuming the seller gains if the auction price is lower than the sale price
Students treat the auction like a normal trade with profit and loss both ways.
Fix: The seller is penalised for default. Do not credit them with a gain from the auction.
Worked examples
Example 1
A seller sold shares at ₹200 on the trade day and failed to deliver. The auction found no seller, so the trade is closed out. The highest price from the trade day to the auction day was ₹212. The official closing price on the auction day was ₹205. What is the close-out price? Options: (a) ₹200 (b) ₹205 (c) ₹212 (d) ₹246
Show the solution
- Candidate 1: highest price from trade day to auction day = ₹212.
- Candidate 2: 20% above the closing price = 205 × 1.20 = ₹246.
- The close-out price is the higher of the two.
- ₹246 is greater than ₹212.
Answer: (d) ₹246
Example 2
A seller sold 1,000 shares at ₹150 and could not deliver. The auction bought the shares at ₹158. What is the seller's loss from the price difference, ignoring penalties and charges? Options: (a) ₹8,000 (b) ₹1,58,000 (c) ₹1,50,000 (d) ₹800
Show the solution
- The auction price is higher than the original price, so the seller bears the difference.
- Difference per share = 158 − 150 = ₹8.
- Total = 8 × 1,000 = ₹8,000.
Answer: (a) ₹8,000
Exam tips
- Remember the sequence: shortage, auction, then close-out. Questions often test the order.
- Learn the close-out price rule as a pair: the highest price from trade day to auction day versus 20% above the auction-day closing price. The higher one wins.
- In any question about who pays, the answer is the defaulting seller.
- Do the arithmetic before looking at the options. Wrong options are often the lower price or the unadjusted closing price.
- Treat bad delivery as a definition: a defective delivery rejected by the buyer. Do not over-think it.
Practice questions from Settlement Process
- Which entity guarantees the settlement of trades executed on a recognised stock exchange in India, even if a counterparty clearing member de…
- A client sells shares held in her demat account through a broker. For the delivery to be settled properly, which action must occur by the pa…
- Broker A has a net pay-in obligation of ₹8 lakh in funds to the clearing corporation for a settlement. The broker has funds shortfall of ₹1 …
- A broker's client sells 500 shares in a T+1 settlement but the shares are held in the client's demat account with a different depository par…
- A clearing member's client sold 500 shares through a broker. The shares were not delivered to the clearing corporation by the pay-in deadlin…
Shortages, Auctions and Close-out: frequently asked questions
What happens if a seller fails to deliver shares?
The shortage goes to an exchange auction, where the clearing corporation buys the shares for the buyer. The defaulting seller bears the cost if the auction price is higher than the sale price. If the auction gets no seller, the trade is closed out.
How is the close-out price calculated?
It is the higher of the highest price from the trade day to the auction day and 20% above the official closing price on the auction day. Always take the higher of the two.
What is the difference between auction and close-out?
In an auction, the securities are bought in the market and delivered to the buyer. In a close-out, the trade is cancelled and the buyer gets money at the close-out price. Close-out is the fallback when the auction fails.
Does bad delivery still matter?
It matters mainly as a concept. Bad delivery means a defective delivery that the buyer rejects, mostly relevant to physical shares. Most settlement is now in dematerialised form.