What Is Buy to Cover?
I'm here to explain buy to cover directly: it's a buy order you place on a stock or other listed security to close out your existing short position. When you short sell, you're selling shares you don't own—they're borrowed from your broker, and you have to repay them eventually.
Key Takeaways
- Buy to cover is a buy trade order that closes your short position.
- Short positions are borrowed from a broker, and buy to cover lets you return those shares to the original lender.
- You make this trade betting that the stock's price will drop, so you sell high and buy back low.
- Buy to cover orders are usually margin trades.
Understanding Buy to Cover
Let me break this down for you. A buy to cover order means you purchase the same number of shares you borrowed, which covers the short sale and lets you return them to the lender—often your own broker-dealer, who might have borrowed them from someone else.
As a short seller, you're wagering that the stock price will fall, so you can buy the shares back cheaper than you sold them. You have to handle any margin calls and repurchase the shares to give them back.
Specifically, if the stock starts rising above your short sale price, your broker might demand you execute a buy to cover as part of a margin call. To avoid this, always keep enough buying power in your account to cover any needed trades before the price triggers that call.
Buy to Cover and Margin Trades
You can trade stocks with cash, buying with your own money and selling what you've bought. But you can also trade on margin, borrowing funds or securities from your broker. Short selling is always a margin trade because you're selling what you don't own.
Margin trading is riskier than cash trades due to potential losses from margin calls. These calls come when the security's market value moves against your position—like when values drop if you're buying on margin, or rise if you're short selling. You must meet these calls by adding cash or making trades to offset the changes.
If you're short and the security's value rises above your short price, the short sale proceeds won't cover buying it back, creating a loss. If it keeps rising, you'll pay more to repurchase. If you don't think it'll drop below your original price soon, cover the short position early.
Example of Buy to Cover
Suppose you open a short position in stock ABC. Your research shows ABC, trading at $100, will fall due to the company's distressed financials. You borrow 100 shares from your broker and sell them at $100.
Then, ABC drops to $90, and you place a buy to cover order to buy back at $90 and return the shares. Do this before a margin call hits. You profit $1,000: $10,000 from the sale minus $9,000 for the purchase.
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