Shorting against the Box

Shorting against the box is another type of hedge, but one which is used for very different reasons. It is basically the shorting of an equal amount of the same stock in which you are currently maintaining a long position. It is generally used as a delaying tactic either for tax or delivery purposes. It puts your positions on hold. For example, if the long position goes up 10 points, the short position goes down 10 points.

Shorting against the Box

Karen Rigg owns 1,000 shares of Citicorp common, which she purchased at $15 per share. The stock is now at $40 per share, and her taxable gain if she were to sell the shares is $25,000. However, it is to her advantage to take these profits next year when she expects to be in a lower tax bracket. But if she tries to hold onto the shares until next year, they may go down in price. Thus, by trying to save tax dollars, she may lose three times as much through price depreciation. She, therefore, informs her broker to sell 1,000 shares "short against the box," and holds onto her short and long positions until after the first of the year. If the stock goes down in price, she gains on the short position while losing on the long. If the stock goes up in price, she gains on the long position while losing on the short. In other words, any price movement in the stock cannot affect her. She locks in her $25 per share profit less the additional commissions the short position will necessitate. However, she also prevents herself from being able to participate in any bullish surge by the stock. But that's the trade-off necessary in shorting against the box. 

Reasons for shorting against the box

There are other reasons for shorting against the box. Sometimes an investor is not in a position to deliver securities in time to her broker, and she opts for also shorting an equal number of shares in the stock in which she is long. In doing so, she locks in her profits until she returns from her European vacation and can access her safe deposit box for the shares to be delivered.

An equally good reason to sell short against the box is the one that follows.

Suppose that someone gives you shares of stock as a gift. These shares have been in their portfolio for years. And suppose that these shares are at a price four times or more above their original purchase price. If you sell the stock, the cost basis for tax purposes is the original purchase price. Thus, you decide to hang on to the stock, for the capital gains are far too much at this time meaning, for someone in your tax bracket.

Good idea! But now assume that the stock is Merck or some other pharmaceutical under tremendous downside pressure because of the Clinton Administration's policies. This puts you between the devil and the deep blue sea. If you sell the stock, the tax impact is enormous. If you keep the stock, you will lose drastically when it plummets. Either way, it seems, you will lose either to the IRS or to the market place.

What to do? You guessed it Sell short against the box until it is advantageous to take your profits or maintain only a long position in the stock.