What is buy to cover

Short sales play several valuable roles in the market. The most common use of a short position is for investors who want to cover their portfolio in case of loss. Taking a well-calculated short position can help investors manage risk. For example, an investor may buy shares of individual tech companies but short the industry as a whole, creating a profitable investment in case something drags down their entire basket of assets.

Although the cost of this risk mitigation is that their short position loses money when their primary investments profit. In a long position your risk is limited by the purchase price of the stock. You can never lose more than your initial investment. You make your purchase, then wait to see what you get back in gains. In a short position your risk is not determined.

This means that an unprofitable trade will lead you to actively lose money when you have to buy back the stock to close out your position. Select personalised ads. Apply market research to generate audience insights. Measure content performance.

Develop and improve products. List of Partners vendors. Buy to cover refers to a buy order made on a stock or other listed security to close out an existing short position. A short sale involves selling shares of a company that an investor does not own, as the shares are borrowed from a broker but need to be repaid at some point. A buy to cover order of purchasing an equal number of shares to those borrowed, "covers" the short sale and allows the shares to be returned to the original lender, typically the investor's own broker-dealer , who may have had to borrow the shares from a third party.

A short seller bets on a stock price going down and seeks to buy the shares back at a lower price than the original short sale price. The short seller must pay each margin call and repurchase the shares to return them to the lender. To prevent this from happening, the short seller should always keep enough buying power in their brokerage account to make any needed "buy to cover" trades before the market price of the stock triggers a margin call.

Investors can make cash transactions when buying and selling stocks, meaning they can buy with cash in their own brokerage accounts and sell what they have previously bought.

Alternatively, investors can buy and sell on margin with funds and securities borrowed from their brokers. Thus, a short sale is inherently a margin trade, as investors are selling something they do not already own.

Trading on margin is riskier for investors than using cash or their own securities because of potential losses from margin calls. Investors receive margin calls when the market value of the underlying security is moving against the positions they have taken in margin trades, namely the decline of security values when buying on margin, and the rise of security values when selling short.

Investors must satisfy margin calls by depositing additional cash or making relevant buy or sell trades to make up for any unfavorable changes in the value of the underlying securities. When an investor is selling short and the market value of the underlying security has risen above the short-selling price, the proceeds from the earlier short sale would be less than what is needed to buy it back.

This would result in a losing position for the investor. Most investors never choose to short a stock and thus never need to buy to cover. But if shorting a stock is appealing to you, then it's important to understand how buying to cover works.

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