Quickrin Finance, an online lender, earns a 48% yield on a Rs 5,000 crore loan book, with funding costs of 12%, credit costs of 10% and operating costs of 14%. A proposed rule would cap lending rates at 36%. What happens to its pre-tax ROA, and how would you frame the short?

The cap takes pre-tax ROA from 12% to zero, because costs of 36 points use up the whole capped yield. Rs 600 crore of pre-tax profit disappears unless Quickrin cuts costs, and even then it earns far less. The short is a bet on the rule passing, with a known date. At today's price the market implies only about a 17% chance of the cap; if you think it is 40%, the short carries an expected gain of about 20% before borrow costs.

Think of a shop with a fixed rent, fixed salaries and a fixed cost of stock. If the government caps its selling price at exactly what the shop pays out, turnover barely changes but profit goes to zero. Quickrin's costs, 12 plus 10 plus 14, add up to 36% of the book, the same as the cap, so every point of yield above 36% was profit and the cap removes all of it. Pre-tax profit falls from Rs 600 crore a year, a 48% pre-tax return on Rs 1,250 crore of equity, to nothing.

No, and a good short thesis says so before the portfolio manager does. Quickrin would lend only to safer borrowers, which could cut credit costs to about 7%, and trim operating costs to about 12%. That gets pre-tax ROA back to about 5%, still less than half of today's 12%, on a smaller book, because safer borrowers are fewer. Existing loans also keep their old rates until they mature, so the profit falls over a year rather than overnight. The thesis survives, but the damage is less than zero forever.

Make the probability explicit. If the cap passes and the stock falls to 0.8x book, Rs 1,000 crore, the short gains 73%. If the rule is dropped and the stock rises 15%, the short loses 15%. Today's price of Rs 3,750 crore implies roughly a 17% chance of the cap, the probability at which the two outcomes balance. If your work on the regulator's intent says 40%, the short's expected gain is about 20%. That is the pitch: the market is underpricing the rule, and the answer arrives on a known date.

Close with the risks that are specific to this short. Borrow can be expensive and scarce in a stock that many funds already short, and a rule being dropped can set off a sharp squeeze. The regulator may soften the cap to 42%, which leaves Quickrin profitable. Size the position so that the 15% loss in the failure case is bearable, and plan to exit on the decision date either way, since after it the thesis no longer exists.