Short Position

Posted in Finance, Accounting and Economics Terms, Total Reads: 329
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Definition: Short Position

In context of stocks, short refers to positions that are owed by the investor. It means that the sale of stocks that are borrowed with the anticipation that the stock prices will drop further. In the case of options, it refers to the writing (sale) of an option contract. It is opposite to the Long position. A short position indicates that the trader is bearish on the outlook of the company.

 

In case of stocks, the trader borrows the stock from a broker or exchange for a specific price and then sells it in the open market at that price. Since he anticipates that the price will fall, if that happens then the trader will buy back the stock at that reduced price and pay back that security to the broker or the exchange. The difference between the price at which he sells and the price at which he buys back is his payoff (excluding the commission paid to the broker/exchange). Thus the trader is known to be in a short position when he has sold off the securities and still not yet bought them back. Thus essentially a trade is said to be in a short position when he has sold securities that he has borrowed from an exchange/broker and promises to pay them back after a certain period of time.


On the other hand, in case of an option contract, a short position refers to selling or writing a Call or Put option as the case maybe. This is because in this case, the option writer has an obligation but not a right to buy or sell underlying securities from the option holder according to his choice.


Since the potential for losses in a short position on stock is unlimited, the exchange or broker may prescribe a margin or collateral that needs to be kept as security and failure to do so may disqualify the trader from short-selling in future.

 

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