Question

Explain the differences between a long forward position and a short forward position. In your answer, illustrate the pay-off functions of these positions with graphs. Fully label your graphs. (note: you are welcome to draw them by hand, take a photo and attach it here)

Answer 1

The difference is one of buying versus selling. The party that takes the long forward position agrees to buy the underlying asset at a specified future date for a specified price. The other party that assumes the short position agrees to sell the underlying asset at the same specified date for the same price. This forms what is known as a forward contract.

A long (or long position) is the buying of a security such as a stock, commodity or currency with the expectation that the asset will rise in value. In the context of options, long is the buying of an options contract. An investor that expects an asset’s price to fall will go long on a put option, and an investor that hopes to benefit from an upward price movement will be long a call option.

With a long position investment, the investor purchases an asset and owns it with the expectation that the price is going to rise. He normally has no plan to sell the security in the near future. A key component of long position investment is the ownership of the stock or bond. This contrasts with the short position investment, where an investor does not own the stock but borrows it with the expectation of selling it and then repurchasing it at a lower price. A key difference between a long position and a short position in investments is what the investor expects to happen to the price of a commodity.

Speculators also go long on futures when they believe the prices will go up. They don’t necessarily want the physical commodity, as they are only interested in capitalizing on the price movement. Before expiry, a speculator holding a long futures contract can sell the contract in the market.

In summary, going long on stocks, bonds, futures and forwards, indicates that the holder of the long position is bullish. However, a long position on options expresses either a bullish or bearish sentiment depending on whether the long contract is a put or a call.