What Is a Position?
A position is the amount of a security, asset, or property that is owned (or sold short) by some individual or other entity. A trader or investor takes a position when they make a purchase through a buy order, signaling bullish intent; or if they sell short securities with bearish intent.
Opening a new position is ultimately followed at some point in the future by exiting or closing the position.
- A position is established when a trader or investor executes a trade that does not offset an existing position.
- Open positions can be either long, short, or neutral in response to the direction of its price.
- Positions can be closed for either a profit or loss by taking the opposite position; for instance, selling shares that were purchased to open a long position.
- Positions may be closed voluntarily or involuntarily (as in the case of a forced liquidation or a bond that has reached maturity).
Positions come in two main types. Long positions are most common and involve owning a security or contract. Long positions gain when there is an increase in price and lose when there is a decrease. Short positions, in contrast, profit when the underlying security falls in price. A short often involves securities that are borrowed and then sold, to be bought back hopefully at a lower price. Depending on market trends, movements and fluctuations, a position can be profitable or unprofitable. Restating the value of an open position to reflect its actual current value is referred to in the industry as “mark-to-market.”
A third type of position is called neutral (or delta neutral). Such a position does not change much in value if the price of the underlying instrument rises or falls. Instead, neutral positions experience profit or loss based on other factors such as changes in interest rates, volatility, or exchange rates. Long-short market-neutral hedge funds make use of these positions, and often use as their benchmark the risk-free rate of return because they do not worry about the direction of the market.
The term position can be used in several situations, as illustrated by the following examples:
- Dealers will often maintain a cache of long positions in particular securities in order to facilitate quick trading.
- A trader closes his position, resulting in a net profit of 10%.
- An importer of olive oil has a natural short position in euros, as euros are constantly flowing in and out of its hands.
Positions can be either speculative, risk-reducing, or the natural consequence of a particular business. For instance, a currency speculator can buy British pounds sterling on the assumption that they will appreciate in value, and that is considered a speculative position. However, a U.S. business that trades with the United Kingdom may be paid in pounds sterling, giving it a natural long forex position on pounds sterling. The currency speculator will hold the speculative position until he or she decides to liquidate it, securing a profit or limiting a loss. However, the business which trades with the United Kingdom cannot simply abandon its natural position on pounds sterling in the same way. In order to insulate itself from currency fluctuations, the business may filter its income through an offsetting position, called a hedge.
Open Positions and Risk
An open position represents market exposure for the investor. The risk exists until the position closes. Open positions can be held from minutes to years depending on the style and objective of the investor or trader.
Of course, portfolios are composed of many open positions. The amount of risk entailed with an open position depends on the size of the position relative to the account size and the holding period. Generally speaking, long holding periods are riskier because there is more exposure to unexpected market events.
The only way to eliminate exposure is to close out or hedge against the open positions. Notably, closing a short position requires buying back the shares while closing long positions entails selling the long position.
Closing Positions and P&L
In order to get out of an open position, it needs to be closed. A long will sell to close; a short will buy to close. Closing a position thus involves the opposite action that opened the position in the first place.
The difference between the price at which the position in a security was opened and the price at which it was closed represents the gross profit or loss (P&L) on that position. Positions can be closed for any number of reasons — to voluntarily take profits or stem losses, reduce exposure, generate cash, etc. An investor who wants to offset his capital gains tax liability, for example, will close his position on a losing security in order to realize or harvest a loss.
Positions may also be closed involuntarily by one's broker or clearing firm; for instance, in the case of liquidating a short position if a squeeze generates a margin call that cannot be satisfied. This is known as a forced liquidation. It also may be unnecessary for the investor to initiate closing positions for securities that have finite maturity or expiration dates, such as bonds and options contracts. In such cases, the closing position is automatically generated upon maturity of the bond or expiry of the option.
The time period between the opening and closing of a position in a security indicates the holding period for the security. This holding period may vary widely, depending on the investor's preference and the type of security. For example, day traders generally close out trading positions on the same day that they were opened, while a long-term investor may close out a long position in a blue-chip stock many years after the position was first opened.
Spot vs. Futures Positions
A direct position in an asset that is designed to be delivered immediately is known as a “spot" or cash position. Spots can be delivered literally the next day, the next business day, or sometimes after two business days if the security in question calls for it. On the transaction date, the price is set but it generally will not settle at a fixed price, given market fluctuations.
Transactions that are not spot may be referred to as “futures” or “forward positions,” and while the price is still set on the transaction date, the settlement date when the transaction is completed and the security delivered date can occur in the future. These are indirect positions since they do not involve outright positions in the actual underlying.