Short and Long Positions

A long position is easier to understand because it conforms to the instincts of a newcomer to financial engineering. In our daily lives, we often "buy" things, we rarely "short" them. Hence, when we buy an item for cash and hold it in inventory, or when we sign a contract that obliges us to buy something at a future date, we will have a long position. We are long the "underlying instrument," and this means that we benefit when the value of the underlying asset increases.

A short position, on the other hand, is one where the market practitioner has sold an item without really owning it. For example, a client calls a bank and buys a particular bond. The bank may not have this particular bond on its books, but can still sell it. In the meantime, however, the bank has a short position.

A short (long) position can be on an instrument, such as selling a "borrowed" bond, a stock, a future commitment, a swap, or an option. But the short (long) position can also be on a particular risk. For example, one can be short (long) volatility—a position such that if volatility goes up, we lose (gain). Or one can be short (long) a spread—again, a position where if the spread goes up, we lose (gain).

7.1.1. Payoff Diagrams

One can represent short and long positions using payoff diagrams. Figure 2-2a illustrates the long position from the point of view of an investor. The investor has savings of 100. The upward-sloping vertical line OA represents the value of the investor's position given the price of the

Short And Long Positions
FIGURE 2-2a Long position of a market.

Gain

Loss

Gain

Loss

0 0

Post a comment