Buy to Cover

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Buy to Cover

Definition

Buy to cover is a buy order used to close an existing short position. In a short sale, an investor borrows shares from a broker and sells them in the market with the intention of later repurchasing the same number of shares at a lower price and returning them to the lender. A buy to cover repurchases those borrowed shares and “covers” the short position.

How it works

  • A trader shorts a security by borrowing shares and selling them immediately.
  • To close the short, the trader places a buy to cover order for the same number of shares.
  • Once the shares are bought, they are returned to the lender and the short position is closed.
  • The short seller profits if the repurchase price is lower than the original sale price; losses occur if the repurchase price is higher.

Margin and margin calls

  • Short selling is a margin transaction because it involves borrowed shares.
  • If the stock price rises after the short sale, the broker may issue a margin call. The short seller must deposit additional funds or close the position by executing a buy to cover.
  • If the price continues to rise, the cost to buy back shares increases, potentially producing unlimited losses for the short seller. Maintaining sufficient buying power helps avoid forced liquidation.

When to cover

Traders typically place a buy to cover when:
* The stock has moved to a target price that realizes profit.
* The market moves against the position and a stop-loss or margin call is triggered.
* New information or changing fundamentals invalidate the original short thesis.

Example

A trader shorts 100 shares of ABC at $100 by borrowing and selling them for $10,000. If ABC falls to $90, the trader places a buy to cover for 100 shares at $90, paying $9,000 to repurchase and return the shares. Net profit = $10,000 − $9,000 = $1,000 (ignoring fees and interest).

Key takeaways

  • Buy to cover closes a short position by repurchasing borrowed shares.
  • Short selling is inherently a margin trade and carries higher risk, including potential margin calls and unlimited losses if the stock rises.
  • Traders should manage buying power and risk controls (e.g., stop orders, position sizing) to limit adverse outcomes.