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Long and Short
Long and Short - Definition
The Long and the Short are the two parties involved in a futures contract.
Long and Short - Introduction
A futures contract is a contract between two parties for the trading of an asset some time in the future at a fixed price. The two parties are known as the "Long" and the "Short". The Long is obligated to buy the underlying asset while the Short is obligated to sell the underlying asset upon maturity of a futures contract.
Although similar in concept with being long or short a stock position, Long and Short in futures trading serve more as nouns than verbs, acting as designation of the two parties involved in a futures transaction and their roles in the contract.
What is Long and Short in Futures Trading?
In stock trading, being long a stock means an ACTION to buy a stock while being short a stock means borrowing and selling a stock which you don't own. In futures trading, the Long refers to the PERSON in a futures transaction that is committed to buying the underlying asset from the person known as the Short. So Long and Short in futures trading refers to the parties rather than a transaction type or order type.
The Long in Futures Trading
When you are the Long in a futures transaction on a physically delivered futures contract, you are entering into an agreement to buy the underlying asset from the short at the price agreed upon. Upon maturity of the futures contract, you are obliged to pay for the underlying asset and the underlying asset transfers from the short to you. This is known as to "Take the Long side of the transaction".
For instance, if you are an airline operator and wants to secure the price of fuel when you restock 3 months later, you would buy futures contracts to buy fuel at a fixed price upon maturity. In this case, you are the Long in this futures transaction.
The Short in Futures Trading
When you are the Short in a futures transaction on a physically delivered futures contract, you are obliged to sell the underlying asset to the Long at the price agreed upon when the futures contract expires. If you do not have the underlying asset in stock, you will be obliged to buy them from the spot market for sale to the Long. In commodities futures, people like wheat farmers who want to secure a fixed selling price for their wheat during harvest usually take the Short side in a futures transaction.
For instance, if you are the producer of a commodity and you are worried that prices for your commodity would fall, you could take the Short side of a futures contract in order to fix a selling price in order to hedge against price volatility.
Long and Short in Cash Settled Futures Contracts
When you are the Long in a cash delivered futures contract, there is no obligation to purchase the underlying asset and all you are really doing is betting on the price of the underlying asset going upwards, just like being long a stock. Conversely, when you are the Short in a cash delivered futures contract, all you are doing is betting on the price of the underlying asset going downwards, just like being short a stock. The underlying asset does not exchange hands at all.