“Buy to cover” is a market order to close a short position by purchasing borrowed shares, which can be forced by a margin call. The goal is to buy at a lower price and return the shares to the lender, but if the stock price rises, the investor may take a loss. Brokers aim to limit financial damage by finding the best prices for the necessary shares.
The term “buy to cover” refers to placing a market order intended to close a short position, restoring the borrowed shares used in a transaction to the lender. People must do this to complete the deal and may be forced to do this as part of a margin call if a broker is concerned about an outstanding stock loan. Individuals can place a purchase order for coverage with a broker or representative, or exercise trading privileges directly to purchase the necessary shares.
In a short position, someone is betting on a fall in the price of a stock. The person makes an agreement to sell a set number of shares at current value, without owning any shares. Instead, the shares are borrowed, usually from a broker. Short traders can generally wait as long as they want to take advantage of the market and close the short position at the right time. When the investor buys to hedge, the shares are purchased at the new market price and given to the lender to take over the loan.
People want to wait for the sweet spot, when the price of a stock has gone down and doesn’t appear to be going down any further, before buying to cover. The goal is to pocket the largest possible difference between two stock prices. The problem arises when the value of a stock goes up instead of down. If the lender isn’t anxious, the borrower can wait and see if the stock’s value falls. More commonly, a broker will issue a margin call, alerting the investor to the fact that they do not have enough funds in their brokerage account to keep it open, and that the funds or securities must be deposited, or the broker will begin liquidating securities.
As part of a margin call, the broker may also specify that the investor must buy to cover. You need to replace the borrowed shares for a short sale within a set period of time. There is the possibility of taking a loss, as the investor may end up paying more for the new shares than the old shares were sold for, and this difference will be covered out of pocket by the investor. A short sale gone wrong can take a significant financial hit.
When someone places a purchase order to hedge, representatives generally try to get the best prices possible by looking at the available options, with the goal of limiting the financial damage.
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