Short sale against the box

CFA Level III
#1

Dont understand how we lock in a price using this method?

Does anyone have a good grasp of this?

#2

dude, chill out… its in the text…

All it is… is borrowing shares of what you own, and then shorting them. You have a riskless position earning the riskfree rate. Now you have money from your short to do whatever you like.

#3

Thats what I dont understand- why do we have to borrow them and then sale shorts?

Cant we just sell shorts directly?

#4

Selling short = borrowing them + selling them

#5

Let me try to simplify it. (good if someone can confirm)

You can simply sell them and be done with the position, why bother borrowing and selling short? Because that will cause tax liability.

If you don’t want to incur tax liability, you can sell them short. But you’ll have to deliver the shares. So you borrow shares instead of using your own.

This way you are long and short both so its not considered an outright sale and will not incur tax liability.

Whoever lent you those stocks, will use your long stocks as colleteral and you’ll earn risk free return on them.

#6

Yes the whole idea is to “hedge” risk on the concentrated asset(s) without having to trigger an immediate taxable situation.

#7

But wont borrowing also have a cost (risk-free return paid). I understand now that we are neutral stock position but dont see how risk free return is locked in?

#8

BUMP

#9

Here’s my take on it:

  • We own 1 share of stock and have a low cost basis (say $10) and the stock trades at higher than our cost basis (say $100).
  • We effectively have a built-in capital gain liability of ($100 - $10) * our tax rate on capital gains.
  • If we want to lock in our profit of $90 and not pay a capital gains tax immediately, we can choose to neutralize our position in the stock by borrowing one share from our broker and selling it short (referred to as a short sale against the box ).
  • We will likely incur borrowing fees for borrowing the stock, but no taxable event is created because on paper our position has been completely offset (we own 1 share of stock and we’ve borrowed and sold short 1 share of stock).
  • This process could occur indefinitely and, as such, capital gains tax could be deferred indefinitely and our profit on the stock would be essentially locked in.

Hope this helps!

OMGMileyCyrus