What is a Short Position?

//What is a Short Position?
What is a Short Position? 2017-10-10T06:44:31+00:00

Definition: A short position indicates an investment strategy in which an investor is selling borrowed stocks in the open market, expecting that the market will drop to realize a profit.

What Does Short Position Mean?

What is the definition of short position? Opening a short position is a way to profit from the declining price of securities by borrowing the underlying asset, selling it in the open market, and expecting that the market price will be lower to buy the securities back at a lower price and replace the securities borrowed.

The strategy is known as short selling, and sophisticated investors are using it to take advantage of the expected decline in the price of the underlying asset. In the case that the securities are paying a dividend before the short position is covered, the short seller should pay the amount of dividend to the broker, i.e. the lender of the securities.

Let’s look at an example.

Example

The stock of company ABC is currently trading at $75 per share, and Marian believes that price will decline in less than three months. Marian asks her broker to short-sell 200 shares of the stock, thus receiving a cash inflow of 200 x $75 = $15,000 in the brokerage account.

Three months later, the stock price of company declines 5%, dropping to $71.25. Marian buys back the 200 shares, thus covering her short position, spending $ 200 x $71.25 = $14,250 to repurchase the shares and return them to her broker.

The profit that Marian makes is $15,000 – $14,250 = $750.

If the stock price had risen 5% to $78.75 instead of dropping to $71.25, Marian would have paid 200 x $78.75 = $15,750 to cover her short position and return the share to her broker. In this case, she would realize a loss of $750.

Nevertheless, short selling is a widely debated options strategy because in the case that many investors sell collectively their shares, the company price will decline dramatically. For this reason, during the recent credit crisis, several institutional investors were not allowed to short-sell the stock of certain banks and financial institutions.

Summary Definition

Define Short Position: Short-position means an investor has borrowed securities to sell in anticipation of the market dropping.