Short Box Explained

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Short Box Spread Explained – Online Option Trading Guide

Short Box Spread explained:

The Short Box Spread is an arbitrage strategy that will be implemented with the combination of Bear Call spread along with Bull Put spread with the same expiry and strike price.

When to initiate a Short Box Spread?

Short Box Spread is initiated to capture riskless profit when the spreads are overpriced in relation to their expiration value.

How to construct a Short Box Spread?

Short Box Spread can be created by Selling 1 ITM call, Buying 1 OTM call, Selling 1 ITM put and buying 1 OTM put of the same underlying security with the same expiry and same strike price. Strike price can be customized as per the convenience of the trader; however, the upper and lower strike must be same for call and put.

Sell 1 ITM Call, Buy 1 OTM Call, Sell 1 ITM Put and Buy 1 OTM Put

Earn risk free profit

Risk-free arbitrage, No risk involved

Let’s try to understand with an example:

Nifty Current spot price (Rs)

Sell 1 ITM call of strike price (Rs)

Premium received (Rs)

Buy 1 OTM call of strike price (Rs)

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Premium paid (Rs)

Sell 1 ITM put of strike price (Rs)

Premium received (Rs)

Buy 1 OTM put of strike price (Rs)

Premium paid (Rs)

Net Premium received (Rs)

Expiration value of Box

Suppose Nifty is trading at 9500. Short Box Spread is currently trading at Rs 216, the actual value of box on expiry should be 200. Since the current value of box is more than its expiration value, a risk free arbitrage of Rs 16 is possible. Selling the box will result in a net premium received of Rs 16,200 (216*75). The expiration value of the box is computed as: 9600-9400=200, which is Rs 15000 (200*75). Since you have collected Rs 216 for shorting the box, your profit comes to Rs 16 after buying it back for Rs 200. Therefore, risk-free profit would be Rs 1,200(16*75).

For the ease of understanding of the payoff, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff chart:

The Payoff Schedule:

On Expiry NIFTY closes at

Net Payoff from 1 ITM Call Sold (Rs) 9400

Net Payoff from 1 OTM Call Bought (Rs) 9600

Net Payoff from 1 ITM Put Sold (Rs) 9600

Net Payoff from 1 OTM Put Bought (Rs.) 9400

short sell against the box

Definition

Use this term in a sentence

“ You may want to try and make a short sell against the box if you think that will be the most profitable way to proceed. ”

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“ The short sell against the box was the best strategy we could employ as we knew the announcement would affect share prices. ”

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“ Since they were hedging against a decline in the stock value, they decided to place a short order and short sell against the box . ”

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Short Sell Against the Box

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.

Understanding Short Sell Against the Box

A “short sell against the box” 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.

Restrictions

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 2020, 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.

Key Takeaways

  • A “short sell against the box” is a strategy used by investors to minimize their tax liabilities by shorting stocks they already own.
  • While it was popularly used by traders in the past, “short sell against the box” has increasingly become a restricted practice after an SEC and FINRA crackdown.

Previous Motivation

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.

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.

Example of Shorting Against The Box

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. To lock in your gains this year, you short the ABC’s shares. As is customary, you borrow shares from a broker on the bet that ABC’s stock price will rise. When your bet comes true, you return the shares that you already owned before the short to the broker, thereby circumventing the taxable event.

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