Skill Sheet: What You Will Learn Here
- Key differences between long and short trades
- Implications of a long and short trade
The world of finance is full of jargon or technical terms that you must be aware of before becoming its active participant. The equity market is no exception.
You may have often heard market experts say, “I am long in the market” or “I am short in the market”. What does long or short in the market mean? Long and short are terms used to indicate a trader’s open position or exposure in the market. When you say you have long position it means you have bought stocks or futures, and when you say you are going short, it implies you have sold stocks or futures.
Indian equity markets do not allow going short on stocks. This means you cannot sell stocks that you do not own. You must either own the stock or borrow it for selling. However, you can short futures i.e., sell futures as it is a derivative instrument. You can also go with long options or short options depending on the market view.
Implications of going long
Going long or buying is simple and has its advantages. Going long on equity stocks or buying shares implies investment or getting ownership with the expectation of the investment gaining value in future. As the stock prices increase so will the value of the investment and vice-versa if the stock prices fall. However, in going long on stocks, the losses are limited to the investment made. The loss cannot be more than what you have invested. Apart from this, an investment receives additional benefits like income in the form of dividends or bonus shares etc.
Going long on futures on the other hand does not come with the above advantages of owing the shares or earning dividends. Long futures as it is known, is used for hedging, arbitrage, or speculation. The chief advantage of going long in futures is it can be done by paying margin money i.e., a fraction of the amount instead of paying the full amount of investment. A significant point to be noted here is that the losses can be unlimited if the long future goes against the expectation that the underlying will go up.
Implications of going short
Going short or selling indicates selling shares in anticipation of a market fall. Selling shares means liquidating an existing investment. You cannot short-sell equities in Indian stock markets as it is not allowed. However, you can borrow and sell shares from the stock lenders for a price and create a short position. A short position implies you are foregoing the ownership and the resultant benefits of being an owner of the shares. In the case of short selling as the stock prices decrease profits are made and if the stock prices increase losses happen.
Going short on futures or selling futures suggests that you need not own the shares. You can go short by paying margin money i.e., a fraction of the amount. Short future is also used for hedging, arbitrage, and speculation. The losses in going short future can be unlimited if the underlying goes against the expectation.
Long and short in options
You can go long or short in options also. Going long or short in options is not as simple as compared to stocks and futures. You must understand the basics of options before going long or short options. Options are of two types namely calls and puts. A call option is a right to buy an underlying not resulting in an obligation. Whereas the put option is the right to sell an underlying not resulting in an obligation. Readers can go through the basics of options trading that we have discussed in the options module.
Long calls mean the market is expected to go up and a call option is bought to profit from it. Long puts mean the market is expected to go down and a put option is bought to profit from it. One can buy options by paying just a fraction of the price of owning the asset known. This is known as the premium. The loss resulting in case of the option going against the expectation is limited to the premium paid. Buying options like buying futures does not give any ownership or benefits.
Short calls on the other hand mean the market is expected to go down and a call is sold to profit from it. A short put means the market is expected to go up and a put is sold to profit from it. Short options imply unlimited risk as a premium is collected and the risk is transferred to the seller from the buyer. Option sellers otherwise known as writers assume the risk of the buyer. Going short on options involves unlimited risk if the underlying fail to move as expected. Selling options is like futures, and margin money is required to sell options.
Knowing the market jargon is important as the market participants use them regularly. Knowing the jargon helps in understanding the way the stock market business is conducted and there is a meeting of mind before a transaction is entered.