Long and Short Positions

Buying (long) and selling (short)

Long and Short Positions

In the trading of assets, an investor can take two types of positions: long and short. An investor can either purchase an asset (going long), or sell it (going short). Long and short positions are further complicated by the two types of options, the call and put. An investor may enter into a long put, a long call, a short put or a short call. Even furthermore, an investor can combined these long and short positions into complex trading and hedging strategies.

 

long and short positions

 

Long Positions

In a long position, the investor is hoping for the price to rise. An investor in a long position will profit from a rise in price. The typical stock purchase is a long stock asset purchase.

A long call position is one where an investor purchases a call option. While this call option can be executed to affect the payout of the underlying stock, the “long” aspect of the trade occurs when the price of the call option itself rises. A call option rises in value when the underlying asset increases in value. Thus, a long call also benefits from a rise in the underlying assets price.

A long put position involves the purchase of a put option. The logic behind the “long” aspect of the put follows the logic of the long call. A put option rises in value when the underlying asset drops in value. A long put rises in value with a drop in the underlying.

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Long Position Profits

In a long asset purchase, the potential downside/loss is the purchase price. The upside is unlimited.

In long calls and puts, the potential downsides are more complicated. These are explored further in our options case study.

 

Short Stock Positions

A short position is the exact opposite of a long position. The investor hopes for and benefits from a drop in the value of the security. Executing or entering a short position is a bit more complicated than purchasing the asset.

In the case of a short stock position, the investor hopes to profit from a drop in the stock price. This is done by borrowing X shares of this company from a stockbroker, and then selling the stock at the current market price. The investor then has an open position for X shares with the broker, that has to be closed in the future. If the price drops, the investor can purchase X shares for cheaper. The excess cash is her profit.

Short stock positions are typically only given to accredited investors, as it requires a great deal of trust between the investor and broker to lend shares to execute the short. In fact, even if the short is executed, the investor may be required to place a deposit or collateral with the broker in exchange for the loaned shares.

 

Other Short Positions

Short call positions are entered into when the investor sells or writes a call option. A short call position is the counter-party to a long call. The writer will profit from the position if the value of the call drops, or the value of the underlying drops.

Short put positions are also entered into when the investor writes a put option. The writer will profit from the position if the value of the put drops, or when the value of the underlying exceeds the strike price.

Short positions for other assets can be executed differently, through a derivative known as swaps. A credit default swap, for example, is a contract where the issuer will payout a sum to the buyer, if an underlying asset fails or defaults.

 

The Bottom Line

As shown above, there is an inherent complexity between long and short positions. The variety of available positions only complicates the executions of trades further. A knowledgeable investor will have grasped the many advantages and disadvantages of each individual type of long and short positions.

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