What is a 'Short Sell Against the Box'
A short sell against the box is the act of short selling securities that you already own. This results in a neutral position where your gains in a stock are equal to the losses. For example, if you own 100 shares of ABC and you tell your broker to sell short 100 shares of ABC, you conducted a short sale against the box.
BREAKING DOWN 'Short Sell Against the Box'This strategy is also known as "shorting against the box." Sellers use this technique when they do not actually want to close out their position on a stock. The strategy is generally used by investors who believe the stock 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.
The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) regulate 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.
An alternative strategy is 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.
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 papers 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.
For example, say you have a big paper gain on shares of ABC. 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.
However, the Taxpayer Relief Act of 1997 (TRA97) no longer allows 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.