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Page history last edited by PBworks 13 years, 11 months ago


Opposite of hedging



Long/ Short

1.  long - you benefit if price goes up 

2.  short - you benefit if price goes down  


              Forward     Type        make money       get (very) hurt


seller:       sells       short        if prices fall            if prices rise

buyer:       buys       long        if prices rise           if prices fall







To "sell short" means the same thing as selling something in the futures market.  i.e. you are promising to sell an asset (stock, bond, physical good) to someone in the future at a specified price.  You might not even own that asset at the present time, but you can sell it forward (short it), which means that you will have to buy it sometime between now and then, so that you can sell it at the specified price.  So, if the price is fixed at which you will sell it in the future, what you are hoping is that the market price of that good will drop between now and that future date, so that you can buy it cheaply, and sell it at a higher price, making a profit.  Selling short is like betting on a price decrease (by selling a contract in the forward market). 


How to short ?

Sell in the futures market.  Sell a futures contract.





To have a long hedge is the same thing as saying that you are planning on buying something in the futures market, at a set price...so you are betting that the price will go up.   If you were speculating, then this would be your only position. 


How to long hedge?

Buy in the futures market.  Buy a futures contract.





Using Credit default swaps to speculate


Credit Default Swaps give a speculator a way to make a large profit from changes in a company's credit quality. A protection seller in a credit default swap effectively has an unfunded exposure to the underlying cash bond or reference entity, with a value equal to the notional amount of the CDS contract.


For example, if a company has been having problems, it may be possible to buy the company's outstanding debt (usually bonds) at a discounted price. If the company has $1 million worth of bonds outstanding, it might be possible to buy the debt for $900,000 from another party if that party is concerned that the company will not repay its debt. If the company does in fact repay the debt, you would receive the entire $1 million and make a profit of $100,000.


Alternatively, one could enter into a credit default swap with the other investor, by selling credit protection and receiving a premium of $100,000. If the company does not default, one would make a profit of $100,000 without having invested anything.


It is also possible to buy and sell credit default swaps that are outstanding. Like the bonds themselves, the cost to purchase the swap from another party may fluctuate as the perceived credit quality of the underlying company changes. Swap prices typically decline when creditworthiness improves, and rise when it worsens. But these pricing differences are amplified compared to bonds. Therefore someone who believes that a company's credit quality would change could potentially profit much more from investing in swaps than in the underlying bonds (although encountering a greater loss potential).





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