What is Short Selling?
Open position is a trading strategy that investors use to profit from a falling financial asset. In an open position, also known as a “short position”, high-priced assets are borrowed first. Then, when the price drops, these assets are actually purchased and returned to the broker.
The answer to the question of what an open position means should be examined within the scope of stock market transactions. This strategy can be used to profit from the decline in the value of stocks. Normally, investors buy stocks when the price rises, planning to sell and make a profit. Open position is the opposite of this situation. Investors create open positions by selling the shares they borrowed from the brokerage house under a special account. This process is called short selling.
What is Short Selling? What is a Short Sale?
Brokerage houses can borrow the shares requested by the investors by supplying them from the large stock inventory they hold or from another firm. In this transaction, the expectation of the intermediary is to buy back the lent shares after a while. In addition, certain fees are requested from the investor during the short selling process. In short selling, the investor first borrows the stocks from the brokerage firm. He then sells them to a third party. The investor, who creates an open position by borrowing the shares and selling them to a third party, is obliged to return these assets to the brokerage firm. In order to fulfill this obligation, it must repurchase the same amount of shares.
If there is a decrease in the price of the shares he bought again compared to the time he made a short sale, the investor makes a profit from this situation. In an open position, buying is done at a high price, while selling is done at a low price. Thus, instead of increasing the value of an asset, a gain is made from its decrease. This strategy is generally used when short-term bearish expectations of several days or weeks are concerned. In the open position, if the value of the asset decreases, money will be made, and when the value increases, there will be a loss.
Example of a Short Sale
Mr. Paul heard that a famous automotive company will initiate a large-scale recall for their new model. In this case, Mr. Paul decides to take an open position, anticipating that the recall will decrease the company’s share value in a few weeks due to high costs and negative news. In this direction, Mr. Paul borrows 100 shares from the broker and sells them short to another investor at the closing price of 50 $ on that day. Two weeks later, with the reaction sales corresponding to the recall news, the share price falls to 28 $. Mr. Paul immediately takes this opportunity to buy 100 shares and returns them to the intermediary institution instead of the previous shares he borrowed. In this situation;
The borrowed 100 shares are sold for 50×100 = 5000$.
For 100 shares bought again, 28×100 = 2800$ is paid.
Thus, Mr. Paul makes a profit of 5000-2800 = 2200$. (It should be noted that commission and other expenses will be deducted from this amount.)
