Short (Short Position)

By JAMES CHEN

Updated Oct 4, 2019

What is a Short (or Short Position)

A short, or a short position, is created when a trader sells a security first with the intention of
repurchasing it or covering it later at a lower price. A trader may decide to short a security when
she believes that the price of that security is likely to decrease in the near future. There are two
types of short positions: naked and covered. A naked short is when a trader sells a security
without having possession of it. However, that practice is illegal in the U.S. for equities. A
covered short is when a trader borrows the shares from a stock loan department; in return, the
trader pays a borrow-rate during the time the short position is in place.

In the futures or foreign exchange markets, short positions can be created at any time.

KEY TAKEAWAYS

 A short position refers to a trading technique in which an investor sells a security with plans to
buy it later.
 Shorting is a strategy used when an investor anticipates the price of a security will fall in the
short term.
 In common practice, short sellers borrow shares of stock from an investment bank or other
financial institution, paying a fee to borrow the shares while the short position is in place.

Short Selling
Understanding Short Positions
When creating a short position, one must understand that the trader has a finite potential to earn a
profit and infinite potential for losses. That is because the potential for a profit is limited to the
stock’s distance to zero. However, a stock could potentially rise for years, making a series of
higher highs. One of the most dangerous aspects of being short is the potential for a short-
squeeze.

A short-squeeze is when a heavily shorted stock suddenly begins to increase in price as traders
that are short begin to cover the stock. One famous short-squeeze occurred in October 2008
when the shares of Volkswagen surged higher as short-sellers scrambled to cover their
shares. During the short-squeeze, the stock rose from roughly €200 to €1000 in a little over a
month.

A Real World Example

A trader thinks that Amazon’s stock is poised to fall after it reports quarterly results. To take
advantage of this possibility, the trader borrows 1,000 shares of the stock from his stock loan
department with the intent to short the stock. The trader then goes out and sells short the 1,000
shares for $1,500. In the following weeks, the company reports weaker than expected revenue
and guides for a weaker than expected forward quarter. As a result, the stock plunges to $1,300,
the trader then buys to cover the short position. The trade results in a gain of $200 per share or
$200,000.

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Related Terms

Bear Trap Definition

A bear trap denotes a decline that induces market participants to open short
sales ahead of a reversal that squeezes those positions into losses.

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Bear Squeeze Definition

A bear squeeze is a situation where sellers are forced to cover their positions as
prices suddenly ratchet higher, adding to the bullish momentum.

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Uncovered Option Definition

An uncovered option, or naked option, is an options position that is not backed by

an offsetting position in the underlying asset.

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What Is Convertible Arbitrage?

Convertible arbitrage is a strategy that involves taking a long position in a

convertible security and a short position in an underlying common stock.

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Short Squeeze and Example

A short squeeze is when a heavily shorted security moves sharply higher, forcing
short sellers to close out their positions and add to the upward pressure. Short
sellers need to be aware of squeezes, as buyers look to profit from them.

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Long Put

A long put refers to buying a put option, typically in anticipation of a decline in the
underlying asset.

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