What it means
A normal, or long, position is bought first and sold later, so it profits from a rising price. A short position reverses the order: you sell first and buy back later, so the profit comes from the fall between the two prices.
The mechanics require borrowing, because you cannot sell something you do not own. A broker sources the shares from another client or an institution, charges a borrowing fee for the loan, and requires the short seller to post margin (collateral held to cover potential losses) for as long as the position is open.
The risk profile is the part that surprises people. A long position can only fall to zero, capping the loss at what you paid, whereas a short position loses money as the price rises and a price has no upper limit, so the potential loss is theoretically unbounded.
Short positions are not only speculative. Market makers run them as a by product of providing prices, and portfolio managers use them to hedge, for instance holding an airline share while shorting a fuel linked instrument so that only the part of the view they actually hold drives the return.
Two practical costs are easy to overlook. The borrower pays a stock loan fee that can be trivial for a widely held share and punitive for a scarce one, and must pass any dividend paid during the loan back to the lender as a manufactured payment.
In practice
Real-world examples.
Example
A fund manager is confident that a heavily indebted retailer will miss its refinancing deadline. She takes a short position worth $2,000,000 so the fund gains if the shares fall, while keeping the rest of the portfolio unchanged.
Example
A commodities desk holds a large physical copper inventory and takes an offsetting short futures position. If the copper price falls, the loss on the inventory is largely covered by the gain on the short, so the desk earns its processing margin rather than betting on prices.
Example
A market maker sells shares to a client without holding them and is briefly short until it buys the stock back in the market. The position is a working consequence of providing liquidity rather than any view on the price.
Think of it
“Short position means you've sold borrowed stock-betting the price will fall.
Formula
Calculation
Profit on a short position = (sale proceeds - repurchase cost) - borrowing and dividend costs
A hedge fund shorts 1,000 shares at $80.00, receiving 1,000 x $80.00 = $80,000 in proceeds. Three months later the price has fallen to $62.00 and the fund buys the shares back for 1,000 x $62.00 = $62,000, giving a gross gain of $80,000 - $62,000 = $18,000. The stock borrow fee was 4% a year on the $80,000 value, which is $80,000 x 0.04 = $3,200 for a full year, or $3,200 x 3 / 12 = $800 for the three months held. Net profit is therefore $18,000 - $800 = $17,200, and had the price risen to $95.00 instead, the fund would have paid $95,000 to close and lost $15,000 before costs.Case study
Seen in the real world.
Ravensgate Partners is a fictional long and short equity fund created solely to illustrate how short positions behave. Ravensgate identified an illustrative listed furniture retailer whose sales were falling while its inventory was rising, and shorted 200,000 shares at $25.00, receiving $5,000,000 of proceeds.
Over the following seven months the retailer issued two profit warnings and the shares fell to $14.00. Ravensgate closed the position for 200,000 x $14.00 = $2,800,000, a gross gain of $2,200,000, against borrow costs of roughly $150,000 over the period.
The fictional detail Ravensgate's partners emphasised afterwards was the two months in the middle when the shares briefly rallied to $31.00 on takeover speculation. The paper loss of $1,200,000 at that point forced an additional margin call, and the fund only survived the position because it had sized it at 3% of the portfolio rather than 15%.
Watch out
Common mistakes.
- Assuming the worst case on a short is losing the amount invested, when losses grow with the price and have no natural ceiling.
- Forgetting the ongoing borrow fee and any dividends that must be reimbursed to the lender, which can quietly erode a correct call.
- Holding a short with no time limit, since a position that is right eventually can still be closed out by margin calls long before that happens.
Questions
People also ask.
How does someone sell a share they do not own?
They borrow it through their broker, sell the borrowed share, and later buy an identical share to return to the lender.
Is a short position the same as short selling?
A short position is the resulting exposure, while short selling is the activity of creating it, so the terms overlap but are not identical.
Can you short something other than shares?
Yes, short exposure can be taken in bonds, currencies, commodities and indices, often through futures, options or contracts for difference rather than by borrowing the asset.
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