Short and Long Positions - Research Paper Example

Short and long positions Forwards and options According to Steven (2000: 2), forwards are mainly agreements made to sell or purchase a commodity at a certain period in the future for a specified price agreed on today by different parties. Options refer to the agreement between two or more parties who want to buy or sale a commodity at a certain future period at a price that determined today. The major difference between a forward and an option is that while a forward contract must occur, an option holds a fifty percent of occurring or not depending on various determinant factors.

A forwards contract exists as it can be utilized in a situation without uncertainty. This is due to firms having incentives to predict their productions by use of the forward contracts. Short and long positions Forwards and options are contracts for sale and purchase of commodities between two parties: the sellers and the buyer. The party agreeing to the sale or possible selling of the commodity in the future at that price is the seller or the short. The other party that is agreeing to purchase or possible purchase of the product in the future is the buyer or the long.

To assume the short positions means to be assuming the position of the seller. The seller hopes that the price worth of the asset will rise over the stipulated time of exchange to more than the value set at the time of agreement for purchase. The assuming of the long positions means to be assuming the position of the buyer. The buyer hopes that the price worth of the commodity will fall over the stipulated time of exchange to less than the price valued at the period of agreement for sale.

The contract in itself costs and limits nothing to enter to but it offers a view and privileged risk of the positions the shot and long hold (Keith, 1997: p. 14). Risks and returns associated with these positions One significant risk that is associated with the holding of both these positions is the risk of loss. In the contract, the short incurs the risk of loss in case the asset's price value rises to a greater amount than that of the agreed future price of sale of the commodity.

This would mean that the seller incurs a loss equal to the value price that the asset has appreciated over the agreed period. Such loss risk is an associated return for the long in the same contract they would have gained an asset at a price agreed upon before its appreciation is lower than the valued price of the commodity at the time of exchange of ownership. Also in case the value of the commodity were to depreciate over the agreed upon period the long incurs the loss of the depreciated value of the commodity.

This is because they would pay according to the agreed upon price before depreciation and, hence, the loss of value by the asset incurred by them (John 2000: p. 34). In the forward contract, there is a substantial possibility of the creation of a credit risk within the contract. In the forwards, there are no daily true-ups being conducted on the price of the commodity. This depicts that the daily rise and change in the price values of the assets is accumulated to be met upon completion of time on the exchange date.

This is risking that the short will fail to deliver the set upon asset, or the long will not be able to pay up to the agreed upon price on the delivery date. There is the possibility of unlimited profit potential by the short in the futures positions. The short in options stands to benefit in profit determined that the indicated futures prices increase. This is mainly caused by the fact that the price of the asset appreciated meaning that the margining updates are met by the buyer long to ensure equitable accomplishment of the contract.

In the forward positions, however, the long stands to accrue unlimited profits in case of the rise in value of the commodity meaning that the payments made would be based on agreements made on the past agreements date value of the asset and not the appreciated exchange date value of the asset. In conclusion, according to Abraham and Patrice (2005: p. 13), like every exchange business, in the forwards and the options there is the risk of failure to deliver by either the short or the long and the possibility of profiting from the meeting up of the agreed upon conditions.

This means that if the short fails to deliver the asset as agreed upon, the long incurs many costs in line with planning and accruement, the short also may acquire a loss if the long fails to deliver on the agreed upon delivery conditions, such as taking care of the daily changes in price value of the commodity. Upon the successful completion, of the agreed upon contract both the long and the short deliver to the other and receive a delivery from the other ensuring the completion of an agreed upon contract.

Bibliography Abraham, L., & Patrice, P., 2005. Forwards and futures: Dynamic commodities Allocation with futures and Forwards. New York: Columbia University Press. John, C., 2000. Trade features: Options, Futures and other Derivatives. London: Prentice-Hall. Keith, R., 1997. Financial Derivatives: An Introduction to Futures, Forwards, Options and Swaps. London: Prentice-Hall. Steven, V., 2000. Forwards and options: an introduction. Rutledge: Birmingham.