Long and Short Position Interaction in the Portfolio

CFA Level I Portfolio Management
#1

Hello folks!

During the backtest simulation ,a very interesting question has aroused… Namely, when we deal with simultaneous Long and Short positions within the same Broker account(one Portfolio).

Example 1

We opened SHORT deal - selling securities of the Company A for 20 000 USD (100 stocks * 200 USD). Finally, the stock prices raised up and we had to close the SHORT position buying securities for the price of 400 USD per 1 stock (instead of 200 USD). As a result, we lost 20 000 USD which was taken out from our Cash Account.

But what might have happened if the SHORT position is opened altogether with the LONG position at the same time taking into account that the LONG position consumes all our Cash Account 20 000 USD and for the SHORT position there is no money to cover it.

Example 2

We opened the first SHORT position (Company A) with 20 000 USD (100 stocks * 200 USD) and at the same time we opened the second SHORT position with amount of 10 000 USD (Company B) (100 stocks * 100 USD). Later on, the stock prices of both companies began to raise up and we started to owe 30 000 USD for the first deal and 20 000 USD for the second deal. And finally we have an empty Cash Account.

Question:

What is the workflow between the SHORT and LONG positions?

It seems that we can’t open one LONG and one SHORT position at the same time for two different companies as there might be a conflict with Cash Account if we open two different position simultaneously. Looks like that broker won’t allow us to do this.

#2

Generally speaking I believe that you would assume that there will be cash in an account to pay for the investments through CFA materials. It does show the risks of borrowing shares (selling short) and the losses that can be incurred.

If you used short sale proceeds to purchase another stock without other capital, you would essentially have to sell your long position to cover your short position losses. If your long position declines in price and your short position increases in price, you’ll be in a real bind and have to call your dad for cash. Basically this emulates a pairs trade (stocks in similar industries selected long and short to eliminate industry risk and make a bet on which will outperform and what will underperform). Keep in mind with short positions you might have to post margin to the broker as well as they’ll want some security/collateral to lend the shares.

I understand the question relating to how you would do it mechanically. If you have $0 to begin with, you’d have to borrow and sell shares first, then using the proceeds to purchase your long position. That would hypothetically be the only realistic order of operations. For the most part though, CFA is going to assume that investors in examples, etc have the capital to make the trade simultaneously with cash to cover losses (just keep in mind the risks). Realistically though you could sell shares and buy shares within a matter of minutes from a personal brokerage account so there really isn’t much delay.