Long–Short Return Calculation

Timothy Peterson

This chapter is intended to provide an introductory understanding of return calculation of a typical long–short portfolio. We start with an illustration of a short sale, and then move on to contribution to return.

One of the key points in the chapter is that shorting and leverage are synonymous. When a manager goes short, that manager is taking on leverage. Similarly, conventional leverage (or almost any leverage) is the same as shorting the asset that is borrowed.

SHORT SELLING

Short selling is the selling of a security that the seller does not own. This is accomplished by borrowing a security, selling it at the current price, purchasing it back later (closing the position) and returning the borrowed instrument to the lender. Selling short is the opposite of going long, and short sellers make money if the security goes down in price. Therefore, short sellers assume that they will be able to buy the security at a lower amount than the price at which they sold short. Because short selling involves borrowing, it is a form of leverage.

For example, suppose we wish to short the common stock of XYZ Corporation. XYZ is currently trading at USD50 per share. A short sale is