Question

Focus and discuss the following.

• Short positions (of regular stocks): define and provide examples.
• Long positions (of regular stocks): define and provide examples.
• Forwards: what are they and give examples of how you would use them.
• Futures: what are they, and give examples of how you would use them.

Answer 1

Short positions are created by a trader when he sells a security upfront with an intention to buy it back ,later at a lower price. The basic reason why someone would do this is to make money out of the analysis he has done or the market movement that he could foresee.

Consider this example: A trader keeps an eye on the quarterly reports of a corporation and expects it to report a loss, triggering a collapse in its stock prices. The trader goes ahead and create a short position, selling the stock prices at, say $1000 per share. Once the prices fall, to about $900, he buys back the same amount of shares to make $100 per share as profit for himself.

Long Position are created by the trader keeping expectations that the prices of the share would increase and thus they could make Money at a later stage. Continuing from the previous example, if the trader believes, that the prices of the stock would eventually increase even beyond $1000 after some time, the trader would go ahead and buy more number of stocks and create a long-position for himself. When the prices rise beyond $1000, he can sell them at a higher price and again make profits.

Forwards

It is a type of derivative instrument, and is a contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today.

Futures

Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset in a predefined time window and rate. This allows a lock in on the price of the security or commodity and hence shields the buyer or seller from price fluctuations.