What does 'Unwind' mean
To unwind is to close out a position that has offsetting investments or the correction of an error. Unwinds occur when, for example, a broker mistakenly sells part of a position when an investor wanted to add to it. The broker would have to unwind the transaction by selling the erroneously purchased stock and buying the proper stock. Generally, the term "unwind" refers to more complicated and layered trades.
BREAKING DOWN 'Unwind'One type of investing that features unwind trading is arbitrage investing. If an investor takes a long position in stocks while at the same time selling puts on the same issue, he will need to unwind those trades at some point. Of course, this entails covering the options and selling the underlying stock. A similar process would be followed by a broker attempting to correct a buying/selling error.
Unwinding is a process of reversing a particular transaction by participating in an offsetting transaction. This process can be used to close a particular position or to correct a trade error.
Closing a Position
Closing a position is the process required to eliminate a particular investment vehicle from a particular portfolio. In the case of securities, when an investor looks to close out the position, the most common action is to sell the security. In the case of shorts, an investor would need to buy out the associated debt, possibly through the acquisition of shares.
Unwinding to Correct Trade Errors
In cases where a broker accidentally performs an incorrect action with an investor's funds, such as buying more of a particular security when the instruction was to sell it, the broker must resell the security that was accidentally purchased to correct the error. If the broker experiences a loss when the erroneous purchase is resold, the broker is responsible for the difference, not the investor.
Other activities that can be considered a trade error include buying or selling a security other than the one specified, buying or selling the incorrect quantity of a security, or trading in prohibited securities. Errors that are caught prior to being fully processed, and successfully canceled, do not require unwinding.
Unwinding and Liquidity Risk
Liquidity risk can have negative effects on an investor's or a broker's ability to unwind a transaction. Liquidity refers to the ease at which a particular asset can be bought or sold. If an asset is less liquid, it is more challenging to find an appropriate buyer or seller, so the liquidity risk is elevated. Regardless of whether a transaction was completed intentionally or accidentally, all risks associated with the particular security still apply when attempting to unwind it.