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Long and Short Positions
Long and Short Positions
In the trading of assets, an investor Equity Trader An equity trader is someone who participates in the buying and selling of company shares on the equity market. Similar to someone who would invest in the debt capital markets, an equity trader invests in the equity capital markets and exchanges their money for company stocks instead of bonds. Bank careers are high-paying can take two types of positions: long and short. An investor can either buy an asset (going long), or sell it (going short). Long and short positions are further complicated by the two types of options Stock Option A stock option is a contract between two parties which gives the buyer the right to buy or sell underlying stocks at a predetermined price and within a specified time period. A seller of the stock option is called an option writer, where the seller is paid a premium from the contract purchased by the stock option buyer. , the call and put. An investor may enter into a long put, a long call, a short put, or a short call. Furthermore, an investor can combine long and short positions into complex trading and hedging strategies.
In a long (buy) 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 Stock Acquisition In a stock acquisition, the individual shareholder(s) sell their interest in the company to a buyer. With a stock sale, the buyer is assuming ownership of both assets and liabilities – including potential liabilities from past actions of the business. The buyer is merely stepping into the shoes of the previous owner is a long stock asset purchase.
A long call position is one where an investor purchases a call option. 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 same 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 asset.
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 Options Case Study – Long Call This options case study demonstrates the complex interactions of options. Both put and call options have different payouts. To study the complex nature and interactions between options and the underlying asset, we present an options case study. .
A short position is the exact opposite of a long position. The investor hopes for and benefits from a drop in the price 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 number of shares Stock What is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms “stock”, “shares”, and “equity” are used interchangeably. of the company from a stockbroker, and then selling the stock at the current market price. The investor then has an open position for X number of shares with the broker, that has to be closed in the future. If the price drops, the investor can purchase X amount of stock shares for less than the total price they sold the same number of shares for earlier. The excess cash Cash Equivalents Cash and cash equivalents are the most liquid of all assets on the balance sheet. Cash equivalents include money market securities, Bankers Acceptances, Treasury bills, commercial paper, and other money market instruments. is her profit.
The concept of short selling is often difficult for many investors to grasp, but it’s actually a relatively simple process. Let’s look at an example that will hopefully help clarify things for you. Assume that stock “A” is currently $50 per share. For one reason or another, you expect the stock price to decline, and so you decide to sell short to profit from the anticipated fall in price. Your short sale would work as follows:
– You put up a margin deposit as collateral for your brokerage firm to loan you 100 shares of the stock, which they already own.
– When you receive the 100 shares loaned to you by your broker, you sell them at the current market price of $50 per share. Now you no longer have any shares of the stock, but you do have the $5,000 in your account that you received from the buyer of your 100 shares ($50 x 100 = $5,000). You are said to be “short” the stock because you owe your broker 100 shares. (Think of it as if you said to someone, “I’m 100 shares short of what I need to pay back my broker.”)
– Now assume that, as you anticipated, the stock’s price begins to fall. A few weeks later, the price of the stock has dropped all the way down to $30 a share. You don’t expect it to go much, if any, lower than that, so you decide to close out your short sale.
– You now buy 100 shares of the stock for $3,000 ($30 x 100 = $3,000). You give those 100 shares of stock to your broker to pay him back for, replace, the 100 shares he loaned you. Having paid back the 100 share loan, you are no longer “short” the stock.
– You have made a $2,000 profit on your short sell trade. You received $5,000 when you sold the 100 shares your broker loaned you, but you were later able to buy 100 shares to pay him back with for only $3,000. Thus, your profit is figured as follows: $5,000 (received) – $3,000 (paid) = $2,000 (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 sale. In fact, even if the short is executed, the investor is usually required to place a margin deposit or collateral with the broker in exchange for the loaned shares.
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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 short call position if the value of the call drops, or the value of the underlying drops.
Short put positions are 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 of the option.
Short positions for other assets can be executed through a derivative known as swaps. A credit default swap, for example, is a contract where the issuer will pay out a sum to the buyer if an underlying asset fails or defaults.
The Bottom Line
There is a wide variety of long and short positions that traders may adopt. A knowledgeable investor will have grasped the many advantages and disadvantages of each individual type of long and short positions before attempting to incorporate using them in his or her trading strategy.
CFD Trade: Going Short and Making a Profit
CFDs allow you to profit from a fall in the price of a share or other market instrument. Even if in the early learning stages of your CFD trading experience you aren’t sure whether you will wish to trade on the short side, you should still dedicate some time learning what ‘shorting’ is about so that your market knowledge is more complete.
A lot of people misunderstand shorting. They think it’s something strange. The way I explain it is this: say you wanted to buy a second-hand BMW and I said: ‘Give me £20,000 and I’ll sell you one’. I don’t have the BMW but I might think ‘I can buy one of those for £18,000 round the corner because I think I spotted one like that’. So I’ve shorted you a BMW. Effectively shorting stock is the same thing. You want to make money out of the stock moving down, so you short it first. At some point in the not too distant future you’re likely to buy that back.
One of the key advantages CFD trading; which is a leveraged based way of trading – is that it empowers you to place a trade whereby you can speculate that the market is going to depreciate in value. You see trading covers not only profiting when prices go up, but also when values fall. When you buy to profit from rising prices it is called going long. The way that you can profit on falling prices is called ‘going short’ or ‘short selling’, and although many people are worried about it when they first start trading, mastering going short is one of the keys to making a profit in good or bad markets. Trading the short side in practice means that you have opened your CFD trade using a sell order or ‘gone short’ to profit from a share price decline. You can go short on stocks, and you can also go short with CFDs. Going short is as easy as going long and although opening a CFD trade using a sell order might sound odds, it’s simply the equivalent of closing out your exposure to the market. You might look to sell short if a share is falling or you think that it is overvalued or you are expecting a profits warning.
When you trade with CFDs, you put up a percentage of the value of the underlying security, and this is called the margin. With stocks, it is often around 10%. Your account is charged each day you have an open CFD position, and you can think of this as interest for the virtual borrowing of the value of the holding. When you go short with CFDs, you still have to put up a margin, as this is security for the broker against you losing, but your account may be credited with daily interest while the position is open. This is because when opening a short positoin you receive a cash payment for the full value of your short position and receive interest on this amount at the RBA rate (in Australia) or Libor rate (in the UK) minus, say 2% per annum. The overnight interest rate is calculated by dividing the per annum applicable interest rate payable by 365 (days per year).
Going short is simply opening a short ‘sell’ CFD position to profit from a share price decline. Here you are anticipating prices to fall and will use a buy order to close your trade position. The obvious benefit of short trading is that you can profit directly from falling asset prices, which is very difficult to achieve without the use of derivative products such as CFDs. We’re all used to buying at £1 and selling at £1.50 – it’s just buying and selling in reverse.
One of the misunderstandings that a lot of traders have when they start trading CFDs is that there is a limited period of time you can stay short. That is not the case. There is a very remote possibility that the short stock that has been borrowed is recalled but this happens very rarely in practice.
What are the things to keep in mind when short-selling stocks?
Ignoring the obvious that you lose money when short positions rise in price but apart from that;
- short selling involves borrowing fees
- you pay out the dividend if you are short on the ex-div date
- forced buy ins can occur if there’s a limited amount of shares available for borrowing
In practice when evaluating a short-selling opportunity it is important to decide on a trade size, and suitable entry and exit targets. If you short-sell a company you also have to take into account any dividend payment that is paid to shareholders while you are short of the shares (since you will have to pay these from your account). Because of this it is pertinent that you check dividend dates so as to avoid liability.
Here’s an example of a short CFD trade -:
Suppose that you believe the price of shares in company AB, now at 125p, is going to fall following a lower than expected profit figures. You can open a short CFD position for, say, 10,000 shares (total market exposure 10,000 x 1.25 = £12,500), and that would require 10% of initial margin amounting to 10,000 x 125p, which is £1250. Commission might be 0.1% (of the value of the underlying shares) which would be £12.50. The total amount required to deposit with the broker to open the position would therefore be £1262.50. (initial margin + commission)
The rate of interest you receive is usually small, perhaps 2% less than the current bank rate. Say you held the position for 30 days, and the interest received was £24. You then close the position for profit, as the share price has dropped to 110p.
You have gained a gross 15p per share (125p open minus 110p close). That means that your 10,000 share trade has gained £1,500 gross. You close by buying back at 110p, which would cost £11 in commission. Your net profit from the transaction would be £1,500 less £23.50 (£12.50 + £11) total commissions plus £24 interest received, which makes £1,500.50
It is important to note that if the trade goes against you, your losses are similarly leveraged or multiplied, and it is possible to lose more than you initially staked.
|Opening Short AB Position||CFD Deal|
|CFDs sold for £1,250 exposure||10,000|
|Margin Requirement (10%)||£1,250|
|Closing Short AB Position||CFD Deal|
|CFDs bought to close position||10,000|
|Position sized closed||£11,000|
|Financing Received* at 2% pa based on Libor rate of 4.5%
[(117p x 10,000) x (Libor – 2%)]/365*30 days
|Net Profit (Gross minus trading cost + financing received)||£1,500.50|
|Return on £1,250 equity deposit||120%|
* Financing is calculated at the average market price of 117p .
Short Selling’ or a ‘short position’ is placed if a trader believes the market price is set to fall. A trader sells the position first and then buys the position back at a later date to close out the trade. This is the opposite to a ‘long position’ or ‘going long’
Long/Short Strategy – Hedging
It is interesting to note that CFDs can also function as insurance (i.e.utilising CFDs as a hedge) rather than just as a means of highly geared speculation. In particular, you may wish to take up a short CFD in shares where you already hold physical long positions, but where you are bearish on the shares’ short-term prospects. In such circumstances, you may wish to avoid on outright sale of shares so as not to incur a CGT liability. The paper loss on the value of the shares is offset by the profit from the CFD trade if the CFD trade is closed out for a profit.
Short CFD Trading Example
Opening a Short (Sell) Trade: Profit
CFD traders usually earn interest on short positions although in practice this is dependent on the underlying currency interest rates. This is something to consider if you wish to hold a short position for the long term.
Example: Short position in Telstra Corporation (TLS).
On 24th June 2020 you believe TLS is in a market correction and take a short position in TLS share CFDs. You decide to place a 50c trailing stop loss.
Opening the position
Telstra Corporation is quoted by your CFD provider at $3.23 bid.
You sell 10,000 Telstra share CFDs at $3.23. The total contract value (i.e. position size) of the trade is: $3.23 x 10,000 = $32,300.
The margin required to open the trade is 10% of the total value of the position and is calculated as follows: $32,300 x 10% = $3,230. Remember if the share price moves against you, it is possible to lose more than this $3,230 initial margin.
In this example commission is charged at 10 basis points. One basis point is 0.01 of a percentage point. To determine how much commission you would pay, you multiply your position size by the commission charge. Here this is $32.30 ($32,300 x 0.10%).
Whilst short you will earn interest on the trade at a rate of 2.25% per day calculated as follows: $32,300 x 2.25% / 365 = $1.99 per day*.
*This will fluctuate according to the daily closing price of Telstra Corporation.
Closing the position
Telstra Corporation reaches lows of $2.11 in mid-August. A stop is then moved down 50c above this level at $2.61. On the 24th August Telstra’s share price reaches $2.01 and you decide to close the position.
You now buy 10,000 TLS share CFDs at $2.01. Profit is calculated as: ($3.23 – $2.01) x 10,000 = $12,200.
The commission charge of 10 basis points will also apply to the closure of the trade, equalling $20.1 (10,000 X 2.01 x 0.10%).
The position earns interest of $1.99 per day for two months: $1.99 x 60 days = $119.40 approximately.
You have also incurred opening and closing commissions of $32.30 and $20.1 respectively totalling $52.40
Your total profit on the trade after deducting the commission charges is: ($12,200 + $119.40) – $52.40 = $12,267 approximately*
* If the position had moved against you, you would have incurred a loss on the trade.
Although contracts for differences should not be regarded as substitutes for long term investment or saving, as more retail investors seek to take control of their financial destiny, there’s been a growing realisation that going short is a legitimate means of trading in a market that’s become increasingly difficult to profit from in a traditional sense.
A Guide to Understanding Opportunities and Risks in Futures Trading
Basic Trading Strategies
Dozens of different strategies and variations of strategies are employed by futures traders in pursuit of speculative profits. Here are brief descriptions and illustrations of the most basic strategies.
Buying (Going Long) to Profit from an Expected Price Increase
Someone expecting the price of a particular commodity to increase over a given period of time can seek to profit by buying futures contracts. If correct in forecasting the direction and timing of the price change, the futures contract can be sold later for the higher price, thereby yielding a profit. If the price declines rather than increases, the trade will result in a loss. Because of leverage, losses as well as gains may be larger than the initial margin deposit.
For example, assume it’s now January. The July crude oil futures price is presently quoted at $15 a barrel and over the coming month you expect the price to increase. You decide to deposit the required initial margin of $2,000 and buy one July crude oil futures contract. Further assume that by April the July crude oil futures price has risen to $16 a barrel and you decide to take your profit by selling. Since each contract is for 1,000 barrels, your $1 a barrel profit would be $1,000 less transaction costs.
|Price per barrel||Value of 1,000 barrel contract|
* For simplicity, examples do not take into account commissions and other transaction costs. These costs are important. You should be sure you understand them.
Suppose, instead, that rather than rising to $16 a barrel, the July crude oil price by April has declined to $14 and that, to avoid the possibility of further loss, you elect to sell the contract at that price. On the 1,000 barrel contract your loss would come to $1,000 plus transaction costs.
Note that if at any time the loss on the open position had reduced funds in your margin account to below the maintenance margin level, you would have received a margin call for whatever sum was needed to restore your account to the amount of the initial margin requirement.
Selling (Going Short) to Profit from an Expected Price Decrease
The only way going short to profit from an expected price decrease differs from going long to profit from an expected price increase is the sequence of the trades. Instead of first buying a futures contract, you first sell a futures contract. If, as you expect, the price does decline, a profit can be realized by later purchasing an offsetting futures contract at the lower price. The gain per unit will be the amount by which the purchase price is below the earlier selling price. Margin requirements for selling a futures contract are the same as for buying a futures contract, and daily profits or losses are credited or debited to the account in the same way.
For example, suppose it’s August and between now and year end you expect the overall level of stock prices to decline. The S&P 500 Stock Index is currently at 1200. You deposit an initial margin of $15,000 and sell one December S&P 500 futures contract at 1200. Each one point change in the index results in a $250 per contract profit or loss. A decline of 100 points by November would thus yield a profit, before transaction costs, of $25,000 in roughly three months time. A gain of this magnitude on less than a 10 percent change in the index level is an illustration of leverage working to your advantage.
Assume stock prices, as measured by the S&P 500, increase rather than decrease and by the time you decide to liquidate the position in November (by making an offsetting purchase), the index has risen to 1300, the outcome would be as follows:
A loss of this magnitude ($25,000, which is far in excess of your $15,000 initial margin deposit) on less than a 10 percent change in the index level is an illustration of leverage working to your disadvantage. It’s the other edge of the sword.
While most speculative futures transactions involve a simple purchase of futures contracts to profit from an expected price increase — or an equally simple sale to profit from an expected price decrease — numerous other possible strategies exist. Spreads are one example.
A spread involves buying one futures contract in one month and selling another futures contract in a different month. The purpose is to profit from an expected change in the relationship between the purchase price of one and the selling price of the other.
As an illustration, assume it’s now November, that the March wheat futures price is presently $3.50 a bushel and the May wheat futures price is presently $3.55 a bushel, a difference of 5¢. Your analysis of market conditions indicates that, over the next few months, the price difference between the two contracts should widen to become greater than 5¢. To profit if you are right, you could sell the March futures contract (the lower priced contract) and buy the May futures contract (the higher priced contract).
Assume time and events prove you right and that, by February, the March futures price has risen to $3.60 and the May futures price is $3.75, a difference of 15¢. By liquidating both contracts at this time, you can realize a net gain of 10¢ a bushel. Since each contract is 5,000 bushels, the net gain is $500.
Net gain 10¢ bushel
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