Long and Short Positions
Long position involves buying an asset with the expectation of its price rising, while a short position involves selling an asset you don't own, anticipating its price will fall
What are Long and Short Positions?
Long and short positions are essentially two positions an investor can take when trading assets. Imagine you're at a marketplace, deciding whether to buy or sell something. That's the basic idea here.
Starting with long Positions, when an investor takes a long position, they're buying an asset with the expectation that its value will increase over time. It's like buying a stock and holding onto it, hoping it becomes more valuable.
Conversely, a short position involves selling an asset with the anticipation that its value will decrease. It's a bit like borrowing something, selling it at the current price, and planning to buy it back later at a lower cost.
Investors have two main options; call and put. A call is a bet that the asset's value will go up, while a put is a wager that it will go down. These add a layer of complexity to the long and short positions.
Within long and short positions, investors can engage in long put, long call, short put, or short call. This allows them to get creative and build complex trading and hedging strategies.
Key Takeaways
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Long positions involve buying assets with the expectation of their price rising, while short positions involve selling assets you don't own, anticipating their price will fall.
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Long positions can lead to profits when asset prices increase, while short positions profit from price decreases.
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Investors can engage in long and short positions through options like call and put options, allowing for diverse trading and hedging strategies.
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Short positions involve borrowing shares to sell them at the current price with the hope of buying them back at a lower price in the future.
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Short selling carries potential profits, but the maximum possible loss is uncertain, making it a strategy with risks and rewards to consider carefully.
Understanding Long-position and Short-Position
Understanding how money moves in the stock market means understanding two key trading positions, long and short.
Long position
A long position in the stock market signifies that an investor has purchased and acquired the stock shares. For instance, if an investor holds 100 shares of Amazon.com Inc. (AMZN), they are considered long on those shares, having fully paid for the cost of ownership.
A long investor, essentially a buyer, expects the stock price to rise. For them, a price increase translates to profit.
When it comes to options, a long call position is established when an investor acquires a call option. Similarly, a long put position is created with the purchase of a put option. In both cases, the term "long" signifies an anticipation of a value increase in the underlying asset.
If the value of the underlying asset drops, a long put option gains value. So, the potential profit from a long position is evident here.
Short Position
Contrary to a long position, a short position implies that the investor owes someone money for stocks but does not currently possess them. Using Amazon.com Inc. (AMZN) as an example, if an investor sells 100 shares without owning them, they are said to have a short position.
Short Position is the complete opposite of a long position. the investor expects to make money if the stock price declines. This is accomplished by borrowing a certain number of shares from a stockbroker and then selling the stock at the going rate. It's a little trickier to execute or open a brief place than it is to buy the asset.
For instance, an investor will have an open position with the broker for X shares that must be closed in the future. If the price falls, the investor can buy the shares back at a lower price than what they sold them for and make some profit.
When you sell stocks with the hope their prices will drop, your biggest profit comes from the difference between the starting price and zero. This guarantees you a maximum profit. However, the possible loss in a short-selling deal is unknown in advance.
A short position is an excellent strategy for an investor who understands the strategy's risk and reward. It's all about using information not everyone knows, going against the common belief in the market, and trying something different.
If the stock price rises instead of falling, the short seller may encounter a margin call. This entails the broker demanding additional cash or securities to augment the margin account's minimum maintenance margin to cover potential losses. A margin call is triggered when the investor's account value dips below a certain level, ensuring there's enough collateral to support the trade.
Example of Short Positions
Assume the investor borrows and shorts the shares at their initial trading price of $90. The share price then climbed to $105, defying investors' expectations that it would fall.
The loss can be calculated as:
- For $27,000, the investor borrows and sells 300 shares at $90 each. The 2% broker fee on $27,000 is $540, and the investor is left with $26,460. The price rises to $105 per share, and the investor buys back 300 shares for $31,500.
- The 2% broker fee of $31,500 is $630, which leaves the investor with $30,870.
- The loss on the transaction is $4,410 ( $26,460 - $30,870 ).
Since it takes a lot of confidence between the investor and broker to lend shares to execute the short sale, short stock positions are usually offered to authorized investors.
In reality, even if the short is performed, the investor is sometimes obliged to give the broker a margin deposit or security in return for the lent shares.
Other Short Positions
When an investor "writes" or sells a call option, a short call position is created. The opposite of a long call is a short call position. If either the call's value or the value of the underlying asset declines, the writer will profit from the temporary call position.
Investors who write a put option engage in a short put position. If the put's value decreases or the underlying value rises over the option's strike price, the writer profit from work.
In contrast, a short position refers to a circumstance in which a trader sells the security or commodity, intending to repurchase it later at a lower price.
With the anticipation of making a profit, long positions are essentially those in which a trader buys:
- Security
- Stock
- Currency
- Commodity
1. Long Position: Buy Low, Sell High
Buying shares of an asset with the expectation that its value will rise over time is known as taking a long position in that asset. Using this method, one purchases stocks at a discount and then sells them for a profit.
After researching the company's solid fundamentals and growth, let's consider that Mr. Z decided to buy 100 shares of stock in Berkshire Hathaway (BRK.A).
Mr. Z purchases 100 shares at a closing price of $90 per share. The total worth of the shares is 100 * $90 = $9000.
One year later, with a hike of $7 per share, the price is $97 per share. So the value of Mr. Z's investment would be 100 * $97 = $9700.
The gain of $700 will be booked in the extended position by Mr. Z using the Buy low Sell high concept.
2. Short Position: Sell High, Buy Low
It is a strategy used by investors who anticipate that the value of an asset will drop temporarily.
A derivative swap can carry out short bets on other assets. If the underlying asset fails or defaults, the issuer of a credit default swap, for instance, will pay the buyer a certain amount. Before attempting to include them in their trading strategy, an experienced investor will understand the benefits and drawbacks of each specific sort of long and short position.
Long Position Vs. Short Position
Analysts and market makers frequently use the terms "long positions" and "short positions" when discussing stocks and options.
Though "long" and "short" can mean various things in economic contexts, long and short positions here relate to the equities an investor needs to own rather than their length.
Long and short positions have significantly different connotations when an investor employs options contracts in an account.
An investor has the right to sell or purchase the securities from the other investor at a specific price; purchasing or holding a call or put option constitutes an extended position.
A short position is created by selling or writing a call or put option because the writer must either purchase or sell shares from the person holding the extended position or the option buyer.
For example,
An individual buys Amazon.com Inc. (AMZN) call option from a call writer for $90.50, and the writer shorts the call.
The strike price on the option is $185.00. If Amazon.com Inc. (AMZN) trades above $303.70 on the market, there is value in exercising the option.
The writer gets the premium payment of $90.50 but is obligated to sell Amazon.com Inc. (AMZN) at $185.00 if the buyer exercises the contract before expiry.
The call buyer (who is long) has the right to buy the shares at $185.00 before expiration and will do so if the market value of Amazon.com Inc. (AMZN) is more significant than $270.50 ($185.00 + $90.50 = $270.50).
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