A short sell against the box is the act of short selling securities that you already own, but without closing out the existing long position. This results in a neutral position where all gains in a stock are equal to the losses and net to zero. The purpose is to avoid realizing capital gains from a sale to close, and so it has been restricted by regulators in practice.
For example, if you own 100 shares of ABC and you tell your broker to sell short 100 shares of ABC without selling your long position, you conducted a short sale against the box - with the long position in one account and the short position in another.
Key Takeaways
A "short sell against the box" is a strategy used by investors to minimize or avoid their tax liabilities on capital gains by shorting stocks they already own.
Instead of selling to close a long position, a long investor would instead sell short the equivalent of the long position in a separate account, creating a neutral position.
While it was popular in the past, the short sell against the box has increasingly become a restricted practice after an SEC and FINRA crackdown.
Alternative strategies exist, such as buying put options.
A short sell against the box, also known as "shorting against the box," is a tax-minimization or avoidance technique used by traders when they do not actually want to close out their long position on a stock. By selling short in a different account and maintaining the long position, no capital gains are realized and any new gains produced by one account will be equally offset by losses in the other.
The strategy is also utilized by investors who believe that a stock they own is due for a fall in price, but do not wish to sell because they believe the fall is temporary and the stock will rebound quickly.
Restrictions and Tax Avoidance
Prior to 1997, the main rationale for shorting against the box was to delay a taxable event. According to tax laws that preceded that year, owning both long and short positions in a stock meant that any paper gains from the long position would be removed temporarily due to the offsetting short position. The net effect of both positions was zero, meaning that no taxes had to be paid.
The Taxpayer Relief Act of 1997 (TRA 97) no longer allowed short selling against the box as a valid tax deferral practice. Under TRA97, capital gains or losses incurred from short selling against the box are not deferred. The tax implication is that any related capital gains taxes will be owed in the current year.
The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) further regulated when sellers are allowed to sell short. For instance, in February 2010, the SEC adopted the alternative uptick rule, which restricts short selling when a stock drops more than 10% in one day. In that situation, those engaging in a short sale (even if the shares are already owned) usually must open a margin account.
A viable alternative strategy is instead buying a put option, which gives investors the right, but not the obligation, to sell the shares. Buying a put option has a per-share cost associated with it, which is comparable to a short sale transaction. However, like all strategies that use options, put options are subject to the effects oftime decay. This represents a cost that must be managed in order for options strategies to work effectively.
Example of Shorting Against the Box
As an example, say you have a big paper gain on shares of ABC in your main brokerage account, which is not a margin account. You think that ABC has reached its peak and you want to sell. However, there will be a tax on the capital gain. Perhaps the next year you expect to make a lot less money, putting you in a lower bracket. It is more beneficial to take the gain once you enter a lower tax bracket.
To lock in your gains this year, you short the ABC's shares in your margin account. As is customary, you borrow shares from a broker. When your bet (hopefully) comes true, you return the shares that you already owned before the short to the broker, thereby circumventing the taxable event.
Is Selling Against the Box Legal?
No, selling short against the box to avoid taxes is illegal under the Taxpayer Relief Act of 1997.
How Does Short Selling Work?
Selling short involves borrowing shares from your broker in order to sell them in the market, with the hope of buying them back at a lower price, for a profit. While the shares are borrowed and shorted, you must pay interest on the value of the borrowed shares. Because of this, short selling is only allowed in margin accounts.
What Is a Box Spread Using Options?
A box spread is an options strategy used to create a synthetic loan, to borrow or lend money at an implied interest rate that may differ from one's traditional lending sources. A box spread involves buying a bull call spread along with a matching bear put spread, where the payoff will always be the difference between the two strike prices. So if you can buy a 100-pt box for $99, it will gain $1 in value by expiration.
For example, if you own 100 shares of ABC and you tell your broker to sell short 100 shares of ABC without selling your long
long
A long—or a long position—refers to the purchase of an asset with the expectation it will increase in value—a bullish attitude. A long position in options contracts indicates the holder owns the underlying asset. A long position is the opposite of a short position.
Short sale against the box, or simply short against the box, is the act of selling short securities that you already own. For example, if you own 200 shares of FON and tell your broker to sell short 200 shares of FON, you have shorted against the box.
Short selling involves borrowing a security whose price you think is going to fall and then selling it on the open market. You then buy the same stock back later, hopefully for a lower price than you initially sold it for, return the borrowed stock to your broker, and pocket the difference.
Here's an example: You borrow 10 shares of a company (or an ETF or REIT), then immediately sell them on the stock market for $10 each, generating $100. If the price drops to $5 per share, you could use your $100 to buy back all 10 shares for only $50, then return the shares to the broker.
Short selling is—in short—when you bet against a stock. You first borrow shares of stock from a lender, sell the borrowed stock, and then buy back the shares at a lower price assuming your speculation is correct. You then pocket the difference between the sale of the borrowed shares and the repurchase at a lower price.
A short sell against the box is the act of short selling securities that you already own, but without closing out the existing long position. This results in a neutral position where all gains in a stock are equal to the losses and net to zero.
Example. If stock XYZ is trading $100 and the investor wants to buy it for the stock $90, they can sell a 90 strike-price put option and collect a $2 premium to do so. If the stock trades down to $90, they will be forced to buy the stock, which is what they wanted, and at the lower price.
In a short sale, the offer is negotiated with the seller, just as in a traditional sale.The offer is then submitted to the lender, not for an “acceptance” but for approval of the terms and net proceeds.
How to Calculate a Short Sale Return. To calculate the return on any short sale, simply determine the difference between the proceeds from the sale and the cost associated with selling off that particular position. This value is then divided by the initial proceeds from the sale of the borrowed shares.
As a short you must pay any dividends or other distributions, and match any tender or exchange offers, made by the stock, so you can lose even if you never cover. Moreover, you can be forced to cover if the lender wants the stock back to vote or for any other reason—or no reason.
Short selling example – Rahul speculates that the current market price of stock ABC at Rs. 200 is way overvalued and expects that once its quarterly financial reports are out in a week, its share price will drop. He borrows 20 ABC stocks and sells them in the market at Rs. 200, thus getting "short" by 20 stocks.
Although the short sale property will be priced according to market value, the lender is highly motivated to sell in order to cut the bank's losses. As a result, buyers can often get a better deal on the home than they would if it was purchased through a typical sale.
The short sale is often preferable to a foreclosure, but it is not a resolution to all a homeowner's financial woes. Aside from potential tax liability and credit implications, if the homeowner is expected to pay the difference between the sale price and the mortgage, that can compound the financial difficulty.
The short seller usually must pay handling fee to borrow the asset (charged at a particular rate over time, similar to an interest payment) and reimburse the lender for any cash return (such as a dividend) that was paid on the asset while borrowed.
Short sellers are wagering that the stock they're shorting will drop in price. If this happens, they will get it back at a lower price and return it to the lender. The short seller's profit is the difference in price between when the investor borrowed the stock and when they returned it.
For example, by having some short exposure, investors can profit when the market declines. They can sell their profitable short positions for cash, and then add to their long positions at lower prices.
The seller borrows securities needed to cover as the stock in the box may be inaccessible, or the seller may not wish to disclose ownership. The traditional motive for this transaction was to defer capital gains taxes. However, this method became infeasible under the Taxpayer Relief Act of 1997.
This is called "shorting against the box." It means you've locked in, or "boxed in," your current profit by initiating a new short position against the stock you're simultaneously holding. If you own, say, 100 shares of stock that had risen from $100 to $150, you have an unrealized profit of $50 per share.
Short sellers are wagering that the stock they're shorting will drop in price. If this happens, they will get it back at a lower price and return it to the lender. The short seller's profit is the difference in price between when the investor borrowed the stock and when they returned it.
Money can be made in equities markets without actually owning any shares of stock. The method is short selling, which involves borrowing stock you do not own, selling the borrowed stock, and then buying and returning the stock only if or when the price drops.
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