I recently learned about short selling against the box and since most people don’t know what this means I thought some of you might benefit from my mistake.
What is Short selling against the box?
This happens when you have a long position and you short it while keeping your long. For example, if you own 10 shares of TSLA and you short 3 and don’t sell your long – you create a boxed short. This means your broker can close out you out of your short position at any time if they need to cover the shorts they have from other accounts for X reasons. Not only that but my broker not just covered my short but also sold the equal amount of longs to cover my short even though I had cash to cover it. At the end of the day this means I was left with 7 shares without ever have any control of it how it was executed. Lastly, you could hold that short for months and months without anything ever happening but as soon as the broker needs to cover other shorts they will close your boxed position. I held mine for almost 9 months without anyone saying anything or any alert being shown communicating it would be closed out at any time.
Why is this prohibited?
From a broker standpoint they use this rule to have liquidity to cover their shorts at any time needed including if you actually own those shares. From a tax standpoint, before 1997 you could have used a box short as a way to avoid paying taxes on your gains for a period of time.
How to circumvent this rule?
Create a separate account and hold the short there. If you only have a short position it’s not considered a box position.