Section 8.6 – Long and Short Positions

  • Long Position

  • Short Position

  • Key Differences: Long vs. Short

1. Long Position:

  • When an investor buys a security, they are said to be long the position.

  • The investor owns the security and hopes the price will rise.

  • This is a bullish position.

  • Profit: Made when the investor sells the security later at a higher price.

  • Risk: The price may fall — maximum loss occurs if the security becomes worthless.

  • Maximum loss: Limited to the amount invested (the cost basis).

  • Cost Basis: What the investor paid for the security.

  • Sales Proceeds: What the investor receives when selling.

  • Order terms:

    • Buy to open (start the position)

    • Sell to close (end the position)

  1. Example:
    Buy 100 shares of XYZ at $40 → Cost basis = $4,000
    If sold later at $50 → Sales proceeds = $5,000 → $1,000 gain

2. Short Position:

  • When an investor sells a security they do not own, they are short the position.

  • This is done by borrowing shares from a broker-dealer and then selling them in the market.

  • The short seller must later buy back the same number of shares to return to the lender.

  • Bearish position → the investor expects prices to fall.

  • Profit: From the difference between sale price (higher) and repurchase price (lower).

  • Risk: If prices rise, the investor must repurchase at a higher price.

    • The potential loss is unlimited because there is no ceiling on how high a stock can rise.

  • Order terms:

    • Sell to open (start the short position)

    • Buy to close (end or “cover” the short position)

  1. Example:
    Sell short 100 shares of ABC at $40 → Receive $4,000
    Later buy back at $30 → Pay $3,000 → $1,000 profit
    If ABC rises to $60 → Pay $6,000 to cover → $2,000 loss

3. Key Differences: Long vs. Short

Feature / Long Position / Short Position

  • Investor action / Buys to open / Sells to open

  • Market view / Bullish (expects price to rise) / Bearish (expects price to fall)

  • Closes by / Selling the security / Buying back (covering)

  • Profit from / Price increase / Price decrease

  • Maximum gain / Unlimited / Limited (price can only fall to 0)

  • Maximum loss / Limited (to cost basis) / Unlimited

Next Section

Long vs Short

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Long vs Short 〰️

✺ Review questions ✺

  • A) Short the position
    B) Long the position
    C) Covered
    ✅ Answer: B) Long the position

  • A) Bearish
    B) Bullish
    C) Neutral
    ✅ Answer: B) Bullish

  • A) Unlimited
    B) The cost basis (amount invested)
    C) The spread
    ✅ Answer: B) The cost basis

  • A) Limited to the spread
    B) The price of the borrowed shares
    C) Unlimited
    ✅ Answer: C) Unlimited

  • A) Buy to open
    B) Sell to open
    C) Buy to close
    ✅ Answer: B) Sell to open

  • “Covering the short.”