Long and Short Positions: Guide to Wall Street Lingo
Rather than an instance of duration, long and short positions are a reference to haves and have-nots. They touch on securities an investor really owns versus securities an investor owes. Basically, the terms “short” and “long” denote what “selling” and “buying” do respectively.
- What is a Long Position?
- What is a Short Position?
- What is Hedging?
- What are Call vs. Put Options?
Investors have long positions when they buy and own assets or contracts.
For example, John owns 50 shares of Apple and is said to be long 50 shares. In other words, he has paid the cost of owning the stock. Oftentimes, long positions benefit from appreciation in the price of financial assets or contracts. In the language of Wall Street, we would refer to this position as “bullish”. If John feels bullish about his Apple stock, he expects its price to rise.
Investors experience short positions when they have sold assets that they do not own; or when they write contracts.
If Melissa sold 50 shares of Apple without yet owning those shares, she is said to be short 50 shares. She owes 50 shares at settlement and must fulfill the obligation to purchase them in the market to deliver. This is a “bearish position” where Melissa hopes for the stock value to fall. The less she pays, the more she saves, right?
In trading, one’s profit is another’s loss. This is what we call a “zero-sum game”!
Sometimes, investors are exposed to both long and short positions at the same time. As a result, the risk subsides. We call such market participants hedgers.
The best way to understand hedging is to think of it as a form of insurance. When investors decide to hedge, they insure themselves against a negative event to their finances. It often involves taking an offsetting position in a derivative to balance any gains or losses to the underlying asset.
Suppose that a company called Agroland specializes in producing fertilizers. It has a major contract due in six months with oil being one of its main inputs. The company is worried about the volatility of the oil market and believes that prices may increase substantially soon.
To protect itself from uncertainty, the company buys a six-month futures contract in oil. In this way, even if the commodity experiences a 10 percent price increase, the futures contract will still lock in a rate to offset it.
As a rule of thumb, “Hedgers must do in the futures market what they would normally do in the future anyway.” Thus, Agroland must buy oil futures today, so it can reduce the risk of oil price fluctuations tomorrow.
Hedging as a market strategy is just the opposite of speculating. The former relies on reducing risk, while the latter on increasing risk.
Call vs. Put Options
Once in a while, you may find yourself confused as to what position you are holding- a short or a long one. That’s when call options come into play! The best way to understand your position is to adhere to what practitioners say, “The long side always holds the option, and the short side writes the option.”
Let’s give a few more details on that.
Buying a call or a put option is a long position. Here, the investor “holds” the right to buy or sell the underlying asset from the writer at the strike price.
Conversely, when an investor sells a call or put, we say they are short. They “write” the option holder the right to buy or sell the asset.
With some contracts, though, the identification of sides is often arbitrary. Take swaps, for example. Essentially, they are derivative instruments in which two parties agree to exchange cash flows, based on an underlying asset at a future point in time. Usually, we call the side that benefits from an increase in the asset price a “long side”.
So, to recap:
- When an investor buys and owns an asset, they hold a long position. It is another word for stock buying.
- When an investor sells an asset they don’t own, they have a short position. It denotes stock selling.
- When an investor holds both short and long positions, we call them hedgers. Hedging implies simultaneous stock selling and buying.
While learning the Wall Street lingo is certainly useful for understanding key terms in trading and investing, another kind of literacy is required to start making informed investment decisions. The volatile nature of the markets makes it imperative that anyone interested in putting their money out there has a strong grasp of the fundamentals of finance. Secure your finances when investing by gaining a strong grasp of such foundational topics as the time value of money, compounding interest rates, and capital budgeting techniques, with our Finance 101 course.
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