Buy to Cover, also known as "Short Position Covering", is the purchase of additional shares of a stock for the express purpose of covering previously shorted shares. Buy to Cover can be used as a trading strategy and/or as part of an overall investment plan. As Buy to Cover implies, this is a purchase of shares with the intent of covering (buying back) previously sold shares. In order to Buy to Cover, you must have a short position in the stock. The Buy to Cover order will be filled at the prevailing market price, regardless of whether it is higher or lower than the price at which the short sale was executed. This is a great strategy for those trying to protect their profits as well as being a good exit strategy for those who are bearish on a company or market, especially if you have an arbitrage opportunity with options. It is also often employed by short sellers entering a position to limit downside exposure while simultaneously aiding in covering their short positions. Buy to Cover may be used as an attempt to lock in some profits or limit losses on a short position that has fallen in price. Moreover, it is also employed on the opposite end of the spectrum when shorts are closing out their position. It can be used as a trading strategy and/or as part of an overall investment plan for those who believe that the price of a certain stock is likely to decline. The time frame for Buy to Cover may vary from trader to trader, with some Buy to Covering as soon as possible, and others Buy to Covering when the price hits their target. Buy to Covering can also protect you from being forced to cover your short position at a higher price. When used correctly, Buy to Cover is a great way for traders to limit losses and take profits on a short position. This prevents a forced buy-in at a higher price, which can occur if the short position is not covered before it rises. Buy to Cover also provides liquidity to the market and helps stabilize prices. There are several benefits of Buy to Cover: There are also several drawbacks of Buy to Cover: Let's say you sell 100 shares of stock short at $10 per share. If the stock falls to $8 per share, you would Buy to Cover at $8 per share, which would mean you would purchase 100 additional shares to cover your short position. If the stock price rises to $12 per share, you would have to Buy to Cover at a higher price, which would mean you Buy to Cover at the prevailing market price. In this Buy to cover example, short-sellers have taken a beating as they would have been better off buying into the downside action instead of entering a sell order. In addition to being forced out of their positions, since there is no uptick rule some short-sellers may have been broken as the prices hit mid-tick during the afternoon. Buy to Cover is a trading strategy and not part of an overall Buy-and-Hold/Long Term Buy and Hold portfolio. It is suitable for investors who want to take advantage of a falling stock price, without the potential downside risk associated with selling short. Buy to Cover can be employed as a short-term investment strategy, or as part of an overall long-term investment plan. It should not be used by investors who are not comfortable with the risks associated with short selling, and who do not have a firm understanding of how the strategy works. In general, Buy to Cover is a sound strategy that can offer several benefits. It is important to weigh the pros and cons before deciding if Buy to Cover is right for you. As with any investment decision, be sure to consult with a financial advisor to get tailored advice for your specific situation. How Buy to Cover Works
Benefits of Buy to Cover
Drawbacks of Buy to Cover
Buy to Cover Examples
Buy to Cover Considerations
Conclusion
Buy to Cover FAQs
Buy to Cover is a trading strategy used to close out a short position by buying shares of the stock that was sold short.
When you sell a stock short, you borrow shares from your broker and sell them in the open market. If the stock price falls, you Buy to Cover at the lower price and profit from the difference between the lower and the higher sale price.
Buy to Cover can provide liquidity to the stock, stabilize prices and keep them from falling too far, and take profits on a short position without having to wait for the stock to rise back to the original sale price.
Some of the drawbacks of Buy to Cover include it can be expensive if the stock price rises and you are forced to Buy to Cover at a higher price, may not always be possible, especially if the number of shares sold short exceeds the available supply a loss if the stock price rises.
It may be used as part of an overall Buy and Hold strategy, or it may be employed in a Buy and Hold portfolio to take advantage of falling prices over time. However, Buy to Cover should not be viewed as anything other than a trading strategy.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
