What Does It Mean to Unwind a Position and How to Execute It?
To unwind a position is to close out a trading position, generally used when the trade is complex or large. Unwinding may also involve the process of correcting a trading error which, depending on its nature, may require multiple steps or trades. For example, if a broker mistakenly sells part of a position when an investor intended to buy more shares, the broker must first repurchase the sold shares and then complete the intended transaction.
Key Highlights
- Unwinding involves closing out a position.
- It typically pertains to large or complex trades.
- It can also refer to correcting trade errors.
Process of Unwinding Explained
Unwinding refers to a multi-step procedure used for closing trades. For instance, an investor who takes a long position in stocks and simultaneously sells puts on the same security must eventually unwind these trades. This means covering the options and selling the underlying stocks. Brokers correcting buy or sell errors also follow a similar process. Ultimately, unwinding is all about reversing or closing a trade through offsetting transactions.
Closing a Position Simplified
Closing a position means eliminating a specific investment from a portfolio. Selling the security is the default action for securities, while covering short shares involves buying them back to close the position. Terming it ‘unwinding’ is appropriate when the buying or selling happens over multiple transactions.
Correcting Trade Errors with Unwinding
Should a broker incorrectly manage an investor’s funds, such as buying more of a security instead of selling it, they must resell the mistakenly purchased security to fix the error before making the intended sale. Any losses incurred during this correction are borne by the broker, not the investor. Errors might include incorrect transactions in terms of the security type, quantity, or prohibited securities. If errors are identified and canceled prior to processing, unwinding is unnecessary.
Addressing Liquidity Risk in Unwinding
Liquidity risk refers to the difficulty in buying or selling an asset easily. Less liquid assets present greater challenges in finding appropriate trading counterparts, hence increasing the liquidity risk. This risk affects both intentional transactions and error corrections, and understanding liquidity is crucial when attempting to unwind a position.
Related Terms: long position, short position, portfolio, liquidity, broker, trading error.
