A position in an asset refers to the volume and direction of a party’s exposure to an asset. When we own an asset, we have a long position and when we owe an asset, we have a short position. When the value of an asset increases, the long position gains, the short position loses and vice versa.
Short position vs long position
In forward contracts and futures contracts, the long position takes delivery and the short position is obligated to deliver), while in options, the party buying/holding the option has a long position and the party writing it has a short position. In case of a call option, a long position to call means long position to underlying and vice versa but in case of a put option, it is exactly inverse, a long (short) put position means a short (long) position in the underlying.
Short sellers sell securities that they borrow. They gain when securities drop in value and lose when they increase such that their gain is limited to 100% while their losses are unlimited. When asset prices move adversely, short-sellers are sometimes forced to buy securities to close their position.
Short rebate rate
When a short seller sells stocks that it borrows, it pays the proceeds to the lender as collateral. Lenders earn interest on the, a part of which they pay back to the short sellers at a rate which is lower than the prevailing money market rate (this rate is called short rebate rate). The security lenders are entitled to dividends and interest that they would have earned had they not lent the securities.
Sometimes traders finance a fraction of the purchase price of securities using a loan they obtain from their brokers. Such a position is called a leveraged position and the loan used to finance a part of it is called a margin loan which is available at an interest rate called the call money rate, which is a few basis points higher than the government bill rate.
Initial margin requirement
The minimum percentage of security value that they must provide out of their own funds is called the initial margin requirement (which is regulated).
The ratio of securities value to margin loan is called the leverage ratio. Leverage magnifies the gain or loss that a trader realizes which is a function of the leverage ratio.
Maintenance margin requirement and margin call
Since an adverse movement in a security’s price can wipe out a trader’s whole equity, brokers require traders to maintain a minimum percentage of equity, called maintenance margin requirement and as soon as their equity percentage drops below it, they receive a margin call, a requirement to replenish their equity.