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.
A gain is a general increase in the value of an asset or property. A gain arises if the current price of something is higher than the original purchase price. For accounting and tax purposes, gains may be classified in several ways, such as gross vs. net gains or realized vs. unrealized (paper) gains.
t the box is the act of short selling securities that you already own, but without closing out the existing long position
long position
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.
For example, let's say John owns 100 shares of XYZ stock and wants to sell them short without revealing his ownership. He borrows another 100 shares of XYZ stock and sells them on the market. If the price of XYZ stock drops, John can buy back the 100 shares he borrowed at a lower price and make a profit.
For example, let's say a stock is trading at $50 a share. You borrow 100 shares and sell them for $5,000. The price subsequently declines to $25 a share, at which point you purchase 100 shares to replace those you borrowed, netting $2,500.
Imagine a trader who believes that XYZ stock—currently trading at $50—will decline in price in the next three months. They borrow 100 shares and sell them to another investor. The trader is now “short” 100 shares since they sold something they did not own but had borrowed.
“A short sale is when a mortgage lender agrees to accept a mortgage payoff amount less than what is owed in order to facilitate a sale of the property by a financially distressed owner. The lender forgives the remaining balance of the loan.”
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.
To short a stock, you'll need to have margin trading enabled on your account, allowing you to borrow money. The total value of the stock you short will count as a margin loan from your account, meaning you'll pay interest on the borrowing. So you'll need to have enough margin capacity, or equity, to support the loan.
You may still owe money after a short sale. In some cases, the lender may take legal action against you to collect the remaining balance — this is called a deficiency judgment. Some states, including California and Nevada, prohibit deficiency judgments after short sales in specific circ*mstances.
Banks are businesses and, just like any business, they are seeking to earn a profit. If it costs more to foreclose over agreeing to a short sale, the bank is very likely to favor the short sale. With foreclosure, a bank takes possession of the house, then resells it at a mortgage auction to the highest bidder.
Since you don't own the stock (you borrowed and then sold it), you must pay the lender of the stock any dividends or rights declared during the course of the loan. If the stock splits during the course of your short, you'll owe twice the number of shares at half the price.
Here's an example: You borrow 10 shares of a company (or an ETF), 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 a risky trade but can be profitable if executed correctly with the right information backing the trade. In a short sale transaction, a broker holding the shares is typically the one that benefits the most, because they can charge interest and commission on lending out the shares in their inventory.
Although the short sale property will be priced according to market value, the lender is highly motivated to sell to cut the bank's losses. As a result, buyers can often get a better deal on the home than they would if they purchased it in typical fashion.
In many cases, short-sale homes are in reasonable condition, and while the purchase price might be higher than a foreclosure, the costs of making the home marketable can be much lower and the disadvantages to the seller can be less severe.
For a short sale to happen, both the lender and the homeowner have to be willing to sell the house at a loss. The homeowner will make no profit, and the lender will actually lose money for selling the house for less than the amount owed.
The strategy is neutral and not dependent on any directional movement from the underlying asset. A short box spread attempts to exploit options mispricing and capitalize on overpriced spreads in the market. Box spreads rely on inefficiencies in option premium pricing.
A trader shorts 100 shares of Infosys at ₹1,000 per share, expecting the price to fall. Contrary to expectations, the stock price rises to ₹1,200 per share. To prevent further losses, the trader decides to cover their short position by buying back the 100 shares at ₹1,200 each.
Imagine a bullish investor trading on the stock of XYZ company. Now, XYZ company is trading at Rs 500 per share but the investor who has a bullish approach and perhaps some insight into the stock believes that the share of XYZ will rise to 600 in a few months.
Shorting is a strategy used when an investor anticipates that the price of a security will fall in the short term. In common practice, short sellers borrow shares of stock from an investment bank or other financial institution, paying a fee to borrow the shares while the short position is in place.
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