Meaning of Cover in Finance
Cover in terms of finance refers to any number of actions that reduce the exposure of an investor. The term, cover, is different from coverage, which applies to insurance coverage in the finance world. Also, the term refers to the financial ratios that calculate a company's margin of protection in servicing its debt and making dividend payments.
Cover is also used literally to denote the act of preserving the overall value of the portfolio, as in providing cover against market volatility.
Let's Understand Cover in Detail
Cover, basically, means taking action to mitigate a legal responsibility or liability. In many instances, this means an offsetting transaction is completed.
For example, if an investor shorts a stock and wants to eliminate the possibility of a short squeeze, she will buy to cover that means she will buy an equivalent number of shares to cover the shares she shorts without owning. This is intended to close out an existing short position.
Cover has some well-defined applications in banking, and also several less well-defined uses. Cover may be used in futures trading to explain buying back a contract that was sold earlier to remove the obligation. This is done when the market conditions clearly aren't being realized, as per the contract seller's expectation.
