Unwind: Definition, How It Works, Uses, and Closing a Position

What Is Unwinding a Position?

To unwind is to close out a trading position, with the term used when the trade is complex or large. Unwinding also refers to correcting a trading error, which may be complex or require multiple steps or trades. For example, a broker mistakenly sells part of a position when an investor wanted to add to it. The broker would have to unwind the transaction by buying the sold shares and then purchasing the shares that should have been bought originally.

Key Takeaways

• To unwind a position is to close it.
• Large and complex trades are candidates for unwinding a position.
• The unwind strategy is also used to correct trade errors.

How Unwinding Works

Unwinding refers to closing trades that require multiple steps, trades, or time. If an investor takes a long position in stocks while selling puts on the same issue, they will need to unwind those trades at some point. This entails covering the options and selling the underlying stock. A similar process would be followed by a broker attempting to correct a buying or selling error.

Unwinding is the process of closing or reversing a trade through an offsetting transaction.

Closing a Position

Closing a position is the process of eliminating a particular investment from a portfolio. In the case of securities, when an investor wants to close the position, the most common action is to sell the security. In the case of shorts, an investor would need to buy back the short shares to close the position. The term unwinding is more likely to be used when buying or selling occurs over multiple transactions. Unwinding is a process.

Unwinding to Correct Trade Errors

If a broker accidentally performs an incorrect action with an investor’s funds, such as buying more of a particular security when the instruction was to sell it, the broker must resell the accidentally purchased security to correct the error. They must then make the original sale requested. If the broker experiences a loss during this error correction process, the broker is responsible for the difference, not the investor.

Other trade errors include buying or selling a security other than the one specified, buying or selling the incorrect quantity of a security, or trading in prohibited securities. Errors that are caught and successfully canceled before being fully processed do not require unwinding.

Unwinding and Liquidity Risk

Liquidity risk can negatively affect an investor’s or broker’s ability to unwind a transaction. Liquidity refers to the ease of buying or selling a particular asset. If an asset is less liquid, it is more challenging to find an appropriate buyer or seller, increasing liquidity risk. Regardless of whether a transaction was intentional or accidental, all risks associated with the particular security still apply when attempting to unwind it.

Liquidity risk can hinder an investor’s or broker’s ability to unwind a transaction when trying to find an appropriate buyer or seller for a less liquid asset. All risks associated with the particular security still apply, regardless of whether the transaction was intentional or accidental.