Is Going Long Considered to Be Less Risky Than Going Short?

03/19/2015 8:00 am EST

Focus: OPTIONS

For the benefit of newbie traders just getting started in—or even just considering—the realm of options, the staff at Investopedia.com compares and contrasts the risk levels of going long versus going short.

Two positions an investor can be in are long or short. A long position is created when an investor buys a security, such as a stock. A short position is the opposite of a long position. There are risks associated with both. Theoretically, a short position has a higher risk than a long position.

When an investor or trader goes long on a security, he buys a security, such as a stock, commodity, exchange traded fund (ETF) or option and expects the value to rise. For example, an investor enters a long position in one call option contract in company XYZ and thinks its stock price will increase. The investor can only lose his premium, the price he paid for the contract. In theory, his risk/reward is defined. In other words, he knows his risk and his potential downside.

On the other hand, when an investor is short on a stock, he borrows shares with the belief that the stock will decrease in value. If he is entering a short position in an option, it is known as writing a contract. Referring to the previous example, suppose the investor shorts one XYZ call option contract. The investor only receives the premium, the price for which he sold one call option contract. This is considered riskier than being long a call option contract because the short position has an unlimited potential loss. The risk in this example is unknown because the stock price can theoretically go to infinity and the investor's reward is confined to the premium he received.

By the staff at Investopedia.com

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