Shopping Cart

Buy to Cover

Buy to cover refers to a purchase order on an open pre-sale asset position that results in its closure. This is also known as selling short. A buy order is used to enter and open the position, and in comparison, a buy to cover is used to exit and close the open position of the shorts.

In fact, in modern markets, a trader is able to pre-sell financial instruments that he or she does not actually own. The trader will borrow market shares through his or her broker or third party with the promise to return it at a later date. The trader must also pay their margin call if the financial instrument price rises above the price which they shorted. 

A trader will buy to cover because they believe that the market price of the financial instrument will decrease. In order to make a profit, they must buy the financial instrument at a lower price than the price at which they pre-sold the financial instrument. 

For example, a trader short sells a stock in a market where it is currently trading at $1000. To do this, they borrow 10 shares of the stock from their broker and sell them at the market price of $1,000 per share. A year later, the stock price fell to $800 per share. The trader places a buy to cover order to buy the 10 shares back at $800 per share, and then returns the 10 shares they borrowed to their broker. Therefore, the trader makes a net profit of:

($1,000 per share * 10 shares) - ($800 per share * 10 shares) 

= $10,000 - $8,000

= $2,000

 



References: 


https://www.warriortrading.com/buy-to-cover-definition-day-trading-terminology/

https://www.investopedia.com/terms/b/buytocover.asp

https://financial-dictionary.thefreedictionary.com/Buy+To+Cover