Long and Short Positions

A long position is the ownership of an asset, such as a stock or bond, held in the expectation that its price will rise. A short position is the reverse: an investor sells an asset they do not own, usually borrowed from someone else, expecting to buy it back later at a lower price and keep the difference. "Going long" profits from rising prices; "going short" profits from falling ones.

Most ordinary investors hold only long positions. Shorts are used by hedge funds, some mutual funds and ETFs, market makers and traders, either to bet on a decline or for hedging. Funds that use both, such as long/short equity funds, often publish their "top 10 long and short positions" in a fund fact sheet, showing the largest bets in each direction. Short selling of US equities is governed by the SEC's Regulation SHO; the EU and UK have their own short-selling rules.

Buying a concert ticket because you think it will sell for more later is a long position. A short position is like borrowing a friend's ticket, selling it today for $100, and promising to hand your friend an identical ticket next month. If the price drops to $60, you buy one, return it and keep $40. If the concert becomes a sell-out and tickets hit $300, you still have to buy one and give it back.

That is why shorting is riskier than buying: a ticket bought for $100 can lose at most $100, but a borrowed ticket that must be replaced has no ceiling on what it might cost.

1. The investor's broker locates shares to borrow, usually from clients' margin accounts or institutional lenders such as index funds.
2. The borrowed shares are sold in the market and the cash proceeds are held as collateral in a margin account.
3. While the position is open, the short seller pays a borrow fee and must pay the lender an amount equal to any dividend declared on the shares.
4. To close ("cover") the position, the investor buys the same number of shares and returns them to the lender.

The profit or loss on a short position is:

• $P_s$ is the price at which the borrowed shares were sold.
• $P_b$ is the price paid to buy them back.
• $N$ is the number of shares.
• $F$ is the total borrow fee, and $D$ is any dividends paid to the lender.

Shorting 100 shares at $50 and covering at $40 gives $(50 - 40) \times 100 = 1{,}000$ before costs. If the borrow fee is 2% a year on the $5,000 position and the trade lasts three months, the fee is about $5{,}000 \times 0.02 \times 0.25 = 25$, so the net gain is about $975. If the price instead rose to $80, the loss would be $(50 - 80) \times 100 = -3{,}000$ plus fees.

Borrow fees depend on supply and demand: widely held shares are cheap to borrow, while heavily shorted "hard to borrow" shares can cost tens of percent a year. In the US, the Federal Reserve's Regulation T requires initial margin of 150% of a short sale's value (the proceeds plus 50%), and brokers set maintenance levels above which a margin call is triggered.

• Unlimited loss. A share price has no upper limit, so losses on a short position have no theoretical cap.
• Short squeeze. When a heavily shorted stock rises, short sellers rushing to cover push it higher still. In January 2021 GameStop's short interest exceeded its public float by some measures, and its price rose more than tenfold within weeks.
• Recall and carrying costs. The lender can recall its shares at any time, and fees and dividend payments eat into returns the longer the position stays open.

Long positions carry ordinary market risk; bought on margin, they also carry the extra risk of leverage, as described under margin trading.

The SEC adopted Regulation SHO in 2004, with compliance from January 2005. Its main elements are:

• Order marking. Sell orders must be marked "long", "short" or "short exempt".
• Locate requirement (Rule 203(b)). Before accepting a short sale, a broker-dealer must borrow the shares, arrange to borrow them, or have reasonable grounds to believe they can be borrowed for delivery, and must document this. Selling without a locate is known as naked short selling.
• Close-out requirement (Rule 204). Clearing firms must close out a failure to deliver from a short sale by the start of regular trading on the day after the settlement date, or face restrictions on further short sales.
• Price test (Rule 201). Adopted in 2010, this "alternative uptick rule" applies when a stock falls 10% or more from the previous day's close: for the rest of that day and the next, short sales generally may be executed only above the current national best bid.

FINRA collects short interest from member firms twice a month and publishes it. In the EU, Regulation (EU) No 236/2012 bans uncovered short sales of shares and requires holders of net short positions to notify regulators from 0.1% of issued share capital and disclose publicly from 0.5%.

A long/short equity fund buys shares it expects to outperform and shorts those it expects to underperform, seeking alpha while reducing exposure to the overall market. A "130/30" fund, for example, holds long positions worth 130% of capital and short positions worth 30%, for net exposure of 100%. Fact sheets for such funds usually show gross exposure (long plus short), net exposure (long minus short) and the top long and short positions by weight. Short exposure can also be created with derivatives, such as a sold futures contract or a bought put option.

• U.S. Securities and Exchange Commission: Key Points About Regulation SHO
• FINRA: Equity Short Interest Data
• European Securities and Markets Authority (ESMA): Short Selling