Long Position vs. Short Position: What's the Difference?
When speaking of stocks and options, analysts and market makers often refer to an investor having long positions or short positions. While long and short in financial matters can refer to several things, in this context, rather than a reference to length, long positions and short positions are a reference to what an investor owns and stocks an investor needs to own.
- With stocks, a long position means an investor has bought and owns shares of stock.
- On the flip side of the same equation, an investor with a short position owes stock to another person but has not actually bought them yet.
- With options, buying or holding a call or put option is a long position; the investor owns the right to buy or sell to the writing investor at a certain price.
- Conversely, selling or writing a call or put option is a short position; the writer must sell to or buy from the long position holder or buyer of the option.
Understanding a Long Position vs. a Short Position
If an investor has long positions, it means that the investor has bought and owns those shares of stocks. By contrast, if the investor has short positions, it means that the investor owes those stocks to someone, but does not actually own them yet.
For instance, an investor who owns 100 shares of Tesla (TSLA) stock in his portfolio is said to be long 100 shares. This investor has paid in full the cost of owning the shares.
Continuing the example, an investor who has sold 100 shares of TSLA without yet owning those shares is said to be short 100 shares. The short investor owes 100 shares at settlement and must fulfill the obligation by purchasing the shares in the market to deliver.
Oftentimes, the short investor borrows the shares from a brokerage firm in a margin account to make the delivery. Then, with hopes the stock price will fall, the investor buys the shares at a lower price to pay back the dealer who loaned them. If the price doesn't fall and keeps going up, the short seller may be subject to a margin call from his broker.
A margin call occurs when an investor's account value falls below the broker's required minimum value. The call is for the investor to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin.
When an investor uses options contracts in an account, long and short positions have slightly different meanings. Buying or holding a call or put option is a long position because the investor owns the right to buy or sell the security to the writing investor at a specified price.
Selling or writing a call or put option is just the opposite and is a short position because the writer is obligated to sell the shares to or buy the shares from the long position holder, or buyer of the option.
For example, an individual buys (goes long) one Tesla (TSLA) call option from a call writer for $28.70 (the writer is short the call). The strike price on the option is $275.00. If TSLA trades above $303.70 on the market, there is value in exercising the option.
The writer gets to keep the premium payment of $28.70, but is obligated to sell TSLA at $275.00, if the buyer decides to exercise the contract at any time before it expires. The call buyer (who is long) has the right to buy the shares at $275.00 prior to expiration, and will do so, if the market value of TSLA is greater than $303.70 ($275.00 + $28.70 = $303.70).
Explaining a Long and Short Position
Long and short positions are used by investors to achieve different results, and oftentimes both long and short positions are established simultaneously by an investor to leverage or produce income on a security.
Long call option positions are bullish, as the investor expects the stock price to rise and buys calls with a lower strike price. An investor can hedge his long stock position by creating a long put option position, giving him the right to sell his stock at a guaranteed price. Short call option positions offer a similar strategy to short selling without the need to borrow the stock.
A simple long stock position is bullish and anticipates growth, while a short stock position is bearish.
This position allows the investor to collect the option premium as income with the possibility of delivering his long stock position at a guaranteed, usually higher, price. Conversely, a short put position gives the investor the possibility of buying the stock at a specified price, and he collects the premium while waiting.
These are just a few examples of how combining long and short positions with different securities can create leverage and hedge against losses in a portfolio. It is important to remember that short positions come with higher risks and, due to the nature of certain positions, may be limited in IRAs and other cash accounts.
Margin accounts are generally needed for most short positions, and your brokerage firm needs to agree that more risky positions are suitable for you.