How is a long call and short stock portfolio equivalent to lending money
hmmm. I think it's because in both cases, you must pay for it up front, before the positions are closed out. You own nothing except the right to buy the stock re: the call, and the obligation to buy the stock re: the short.  You buy a call, but must borrow the stock, for which you must put some margin collateral and there is a cost to borrow. You pay for that, of course.  I wouldn't call it lending though.
"It is true, as farnsy noted, that you generally do not know when stock that you're holding has been loaned by your broker to someone for a short sale, that you generally consent to that when you sign up somewhere in the small print, and that the person who borrows has to make repay and dividends. The broker is on the hook to make sure that your stock is available for you to sell when you want, so there's limited risk there. There are some risks to having your stock loaned though.  The main one is that you don't actually get the dividend.  Formally, you get a ""Substitute Payment in Lieu of Dividends.""  The payment in lieu will be taxed differently.  Whereas qualified dividends get reported on Form 1099-DIV and get special tax treatment, substitute payments get reported on Form 1099-MISC. (Box 8 is just for this purpose.)  Substitute payments get taxed as regular income, not at the preferred rate for dividends. The broker may or may not give you additional money beyond the dividend to compensate you for the extra tax. Whether or not this tax difference matters, depends on how much you're getting in dividends, your tax bracket, and to some extent your general perspective. If you want to vote your shares and exercise your ownership rights, then there are also some risks.  The company only issues ballots for the number of shares issued by them.  On the broker's books, however, the short sale may result in more long positions than there are total shares of stock. Financially the ""extra"" longs are offset by shorts, but for voting this does not balance. (I'm unclear how this is resolved - I've read that the the brokers essentially depend on shareholder apathy, but I'd guess there's more to it than that.) If you want to prevent your broker from loaning out your shares, you have some options:" tl;dr- libor plus a small (&lt;50bps) spread for S&amp;P500 exposure. larger spread for less liquid/ more esoteric index.   a swap is basically just outsourcing balance sheet to a dealer bank. the counterparty (dealer) is shorting you (the fund) the return of the index. to hedge their short, the dealer would borrow funds and buy the stocks in the index. large dealer banks can borrow at basically libor. they'll also expect compensation for the transaction costs of buying the hedge plus a profit on the (small amount) of capital they need to finance this transaction. this will vary based on the size of the portfolio.   s&amp;p500 costs maybe 5bps in transaction cost. an EM index costs maybe 50bps. so it will depend on the index.  profit to the dealer depends on supply/demand dynamics. sometimes this transaction will be in demand, sometimes the short side will be more valuable.   so it depends on the index you're talking about as well as market dynamics. right now for s&amp;p500 exposure, not more than libor plus 50 for a mid-sized fund. Rich's answer captures the basic essence of short selling with example. I'd like to add these additional points: You typically need a specially-privileged brokerage account to perform short selling.  If you didn't request short selling when you opened your account, odds are good you don't have it, and that's good because it's not something most people should ever consider doing.  Short selling is an advanced trading strategy.  Be sure you truly grok selling short before doing it. Consider that when buying stock (a.k.a. going long or taking a long position, in contrast to short) then your potential loss as a buyer is limited (i.e. stock goes to zero) and your potential gain unlimited (stock keeps going up, if you're lucky!)   Whereas, with short selling, it's reversed: Your loss can be unlimited (stock keeps going up, if you're unlucky!) and your potential gain is limited (i.e. stock goes to zero.)   The proceeds you receive from a short sale – and then some – need to stay in your account to offset the short position.  Brokers require this.  Typically, margin equivalent to 150% the market value of the shares sold short must be maintained in the account while the short position is open. The owner of the borrowed shares is still expecting his dividends, if any.  You are responsible for covering the cost of those dividends out of your own pocket.  To close or cover your short position, you initiate a buy to cover.  This is simply a buy order with the intention that it will close out your matching short position.   You may be forced to cover your short position before you want to and when it is to your disadvantage!  Even if you have sufficient margin available to cover your short, there are cases when lenders need their shares back.  If too many short sellers are forced to close out positions at the same time, they push up demand for the stock, increasing price and deepening their losses.  When this happens, it's called a short squeeze. In the eyes of the public who mostly go long buying stock, short sellers are often reviled. However, some people and many short sellers believe they are providing balance to the market and preventing it sometimes from getting ahead of itself. [Disambiguation: A short sale in the stock market is not related to the real estate concept of a short sale, which is when a property owner sells his property for less than he owes the bank.] Additional references: In this example, Client A has to buy shares to return them to Client B for his sale (closing Client A's short position).  Client B then sells the shares.  The end result is there are no shares within the brokerage clientele anymore, so Client A can't borrow them anymore.    The broker is just an intermediary, they wouldn't go out and acquire securities on their own for the benefit of a client wanting to short it, as they would be taking on the risk of the opposite position.  This would be in addition to the risk they already take on when allowing people to short sell -- which is that Client A won't have the money to buy the shares it owes to Client B, in which case the broker has to make Client B whole. "The applicants go through the same process as for any other loan.  The only difference is that the ""bank"" is people like me, perhaps 200 of us on a note.  We kick in $25 or so on each note and get the opportunity to ask the applicant questions.  The investors pay a small percentage as fees to have professionals rate the notes.  The worse the credit, the higher the interest rates the note holder recieves.  Of course if the person stops paying, we receive nothing.  Calculated risk.    I invest in high risk notes sometimes depending on what it's for and have several in my portfolio.  It's literally microlending.  I can afford to lose $25 on a risky loan or two for a 19% profit because the rest of my portfolio is diversified into hundreds of 9-11% notes.  It works surprisingly well." If you hold a future plus enough cash collateral it is economically equivalent to owning the underlying asset or shorting the underlying asset. In general financial assets such as stock indices have a positive expected return - that's the main difference between investing and gambling. There's nothing that special about futures, they are just another contractual form of asset ownership.  Well, one difference is that regulations or brokerages allow individual investors more leverage with options and futures than with straight borrowing. But this is more a regulatory issue than a conceptual issue with the securities themselves. In theory regulators or brokers could require you to hold enough collateral to make a future equivalent to buying the underlying. "My problem with your argument is that you don't have one.   I'm sorry you cannot grasp the difference between mortgage backed securities and company stock or the difference between a short sale and buying a credit default swap. You keep spouting unrelated ""facts"" as if the mean something.  Did big banks short sale FB?  Who knows?  Did they buy FB CDOs?  No they didn't.  There is no such thing. Did they buy credit default swaps? No." "When I have stock at my brokerage account, the title is in street name - the brokerage's name and the quantity I own is on the books of the brokerage (insured by SIPC, etc).  The brokerage loans ""my"" shares to a short seller and is happy to facilitate trades in both directions for commissions (it's a nice trick to get other parties to hold the inventory while you reap income from the churn); by selecting the account I have I don't get to choose to not loan out the shares." "It may be margin loans or credit lines given to brokerages. I have no idea what a loan book is though so don't I don't really know. Also no one ""plays"" in equity markets with borrowed money unless they know for sure what they are doing or they have collateral as in the case of margin." But by closing the short position the broker would still be purchasing shares from the market no? Or at least, someone would be purchasing the shares to close the short position. So, why doesn't the broker just let Client A keep their short position open and buy shares in the market so that Client B can sell them...I know it sounds a bit ridic, but not much more so to me than letting Client A borrow the shares to begin with! "There's no free lunch. Here are some positions that should be economically equivalent (same risk and reward) in a theoretically-pure universe with no regulations or transaction costs: You're proposing to buy the call. If you look at the equivalent, stock plus protective put, you can quickly see the ""catch""; the protective put is expensive. That same expense is embedded in the call option. See put-call parity on Wikipedia for more: http://en.wikipedia.org/wiki/Put%E2%80%93call_parity You could easily pay 10% a year or more for the protection, which could easily eat up most of your returns, if you consider that average returns on a stock index might be about 10% (nominal, not real). Another way to look at it is that buying the long call and selling a put, which is a synthetic long position in the stock, would give you the put premium. So by not selling the put, you should be worse off than owning the stock - worse than the synthetic long - by about the value of the put premium. Or yet another way to look at it is that you're repeatedly paying time value on the long call option as you roll it. In practical world instead of theory world, I think you'd probably get a noticeable hit to returns just from bid-ask and commissions, even without the cost of the protection. Options cost more. Digressing a bit, some practical complications of equivalency between different combinations of options and underlying are: Anyway, roughly speaking, any position without the ""downside risk"" is going to have an annual loss built in due to the cost of the protection. Occasionally the options market can do something weird due to supply/demand or liquidity issues but mostly the parity relationships hold, or hold closely enough that you can't profit once expenses are considered. Update: one note, I'm talking about ""vanilla"" options as traded in the US here, I guess there are some somewhat different products elsewhere; I'm not sure exactly which derivatives you mean. All derivatives have a cost though or nobody would take the other side of the trade." Not really. The lender is not buying the stock back at a lower price. Remember, he already owns it, so he need not buy it again. The person losing is the one from whom the short seller buys back the stock, provided that person bought the stock at higher price.  So if B borrowed from A(lender) and sold it to C, and later B purchased it back from C at a lower price, then B made profit, C made loss and A made nothing . If you mean the percentages of long/short positions within a mutual fund or ETF, then it's a percentage of the total value of the fund portfolio. In that case, positions of 50% in X, -50% in Y are not the same as 100% in X, -100% in Y. If the long and short positions are both for the same asset, then, as D Stanley mentions, all that matters is the net position. If you're equally long and short X, then the net position is always 0%. If it helps you to think about it, long is equivalent to betting for the upside and short is equivalent to betting for the downside. If you are long on options, then you expect the value of such options to increase.  If you are long an option, then you own the option.  If you are short an option, then generally you sold the option.  Someone who is short a call (sometimes called the writer or occasionally the issuer) has sold a call option to someone who is now long a call. Buying a call option that will increase in value is itself a form of investment, just as it's investment to buy stock or other instruments hoping they will appreciate in value.  An option's value will rise or fall with the underlying, so being long an option is a way to be long in the underlying.  Someone can be long in a stock by buying the stock, or long in a call by buying call options in the stock.  The long call generally requires less initial investment than buying the underlying, and lets the option-holder avoid the asset downside during the option term.  The risk is that the asset may not appreciate to the point that the call option will pay off. In the conceptual sense, a share of stock is a particular right to the profits and assets of a corporation, both in form of dividends and in liquidation.  An option is a particular right to the the share of stock.  It's just a further way to formalize and subdivide the various property rights that exist in a corporation.  If you can buy a piece of paper with particular rights to corporate profits and assets, then you can buy another piece of paper with particular rights to the former piece of paper. Like an S&amp;P 500 ETF?  So you're getting in some cash inflow each day, cash outflows each day.  And you have to buy and sell 500 different stocks, at the same time, in order for your total fund assets to match the S&amp;P 500 index proportions, as much as possible.  At any given time, the prices you get from the purchase/sale of stock is probably going to be somewhat different than the theoretical amounts you are supposed to get to match, so it's quite a tangle.  This is my understanding of things.  Some funds are simpler - a Dow 30 fund only has 30 stocks to balance out.  Maybe that's easier, or maybe it's harder because one wonky trade makes a bigger difference?  I'm not sure this is how it really operates.  The closest I've gotten is a team that has submitted products for indexing, and attempted to develop funds from those indexes.  Turns out finding the $25-50 million of initial investments isn't as easy as anyone would think.