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A buy trade order known as a “buy to cover” closes a trader’s short position.
A purchase to cover transaction enables short positions to be “covered” and returned to the original lender after being borrowed from a broker. Shares are sold at a higher price and then bought back at a lower price in this trade because it is anticipated that a stock’s price will drop. Margin trades are typically buy to cover orders. In particular, the short seller’s broker may demand that the seller execute a purchase to cover order as part of a margin call when the stock starts to rise above the price at which the shares were shorted.
The shares can then be returned to the original lender, often the investor’s own broker-dealer, who may have had to borrow the shares from a third party. A purchase to cover order, which entails buying an identical number of shares to those borrowed, “covers” the short sale.
A short seller hopes to repurchase the shares at a price below the initial short sale price by betting on the stock price falling. Each margin call must be satisfied by the short seller, who must then buy the shares back and deliver them to the lender.
To avoid this, the short seller must always have sufficient purchasing power in their brokerage account to execute any necessary “buy to cover” trades prior to the market price setting off a margin call.
