What's the reasoning behind the law that you can't have a long and short position of the same stock?

Question

It's not allowed to own a stock and have a short position of the same stock at the same time (without closing out the position). What's the reasoning behind that? It doesn't make sense from a practical point of view, but why would it be a law?

Answer 1

I wasn't aware it was a law but it does have practical applications and could easily be done using two different brokers.

Let's say you're looking at a stock that is coming up to earnings and you don't know which way it might go.

Broker 1: Enter a buy for 1000 shares at $10.00 then place a stop at $9.90.
Case 1: Earnings are good, the stock goes up and you make money.
Case 2: Earnings are bad and the stock goes down, you get stopped out after losing 10 cents.

Broker 2: Enter a short for 1000 shares at $10.00 then place a stop at $10.10
Case 1: Earnings are good and the stock goes up, you get stopped out after losing 10 cents.
Case 2: Earnings are bad and the stock goes down, you make money.

Now, in Case 1, earnings are good and the stock starts to climb. When it reaches $10.10, you're up 10 cents on the long and down 10 cents on the short - breakeven. But now the stop kicks in on the short ending your losses while the long continues to climb up to $10.20, $10.30 all the while making you money.

Same thing happens in the other direction if earnings are bad. You're covered (hedged) no matter which way the stock goes.

I've never done this with stocks but have done hedging like this in the currency market where it is a common practice.

Answer 2

you could do a similar with out ideas. I did it as we talk. I went lengthy on a inventory this morning which I kept open. Then shorted it later contained in the afternoon and closed that component out. I have stocks that I have owned for decades, i pick to carry the lengthy stocks, yet short at the same time as the inventory stumbles. you've eradicated chance on your scenerio yet the position is the reward?.

Answer 3

If you think the stock will make a big move either up or down you can buy a put option and a call option on it and profit if the move goes in either direction.

Answer 4

because it really doesnt make sense!
you are betting against yourself, if it goes up, you win and lose.... and if it goes down you win and lose, so whats the point?

Answer 5

to hedge position