What is Cover?
In finance, "cover" is a broad term encompassing various actions designed to protect investors from potential losses. It differs from "coverage," which has two distinct meanings: insurance protection and a financial ratio indicating a company's ability to meet its financial obligations. Beyond these specific contexts, "cover" can also refer to general strategies for safeguarding a portfolio's value, such as those employed to mitigate market volatility.
How Cover Works
Cover in finance essentially involves actions to mitigate legal responsibilities or liabilities. This often entails an offsetting transaction. For instance, an investor shorting a stock might "buy to cover" to eliminate the risk of a short squeeze by purchasing an equal number of shares. This closes out the short position. While the concept has specific applications in banking, its usage can be broader. In futures trading, "covering" refers to buying back a previously sold contract to avoid potential losses when market conditions deviate from expectations.