Closing a short position involves buying back the shares that were initially borrowed and returning them to the lender. This action is also known as "covering the short."
Here's a breakdown:
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Initial Short: A trader sells borrowed shares, hoping the price will fall so they can buy them back at a lower price and profit from the difference.
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Closing (Covering): To close the short position, the trader must reverse the initial transaction. This means:
- Buying Shares: The trader buys the same number of shares they originally borrowed in the open market.
- Returning Shares: The purchased shares are then returned to the lender (usually a broker).
The profit or loss on the short position is the difference between the price at which the shares were initially sold and the price at which they were bought back to close the position, less any brokerage fees or interest paid on the borrowed shares.
For example:
- A trader shorts 100 shares of Company XYZ at $50 per share.
- The trader believes the price will decrease.
- Later, the trader buys back 100 shares of Company XYZ at $40 per share to close the position.
- The trader makes a profit of $10 per share (before fees), totaling $1000.
It is important to note that if the price of the shares increases instead of decreases, the trader will incur a loss when closing the short position. This is because they would have to buy the shares back at a higher price than they initially sold them for.
