# Shorting Against The Box To Defer Tax



## Park (Sep 11, 2010)

horting against the box involves shorting a stock that you already own. If you have an unrealized capital gain on the stock, you can lock in that gain until the short position is covered. So you can defer tax until the short position is closed out. If you will be in a lower tax bracket next year, but are concerned that the stock will decline in price in the short term, shorting against the box might result in a tax saving.

Shorting against the box for tax planning isn't allowed in the US. I've found it difficult to get information about Canada, but it looks like the same.

However, does it apply to similar stocks? For example, you own an S&P500 ETF. Could you short against the box using a Russell 1000 ETF?

I have read in the US that shorting against the box is allowed, if you close the short position no longer than 30 days after the start of the year and hold the stocks for at least another 60 days after covering the short position ( https://www.briefing.com/investor/learning-center/strategies/Selling-Short-Against-the-Box/ )

Does this also apply in Canada?


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## humble_pie (Jun 7, 2009)

discount brokers tend to be allergic to shorting the box. However what you are describing - holding or shorting one security while going short or long in a lsimilar security - are common pair trades that are often practiced by both retail investors & professional fund managers alike. In a fund, such pairings are often called "sampling."

pairings also entrain some level of risk & one cannot expect that they will track evenly. It would be possible to diminish tracking error by adding option positions but i don't actually see the benefit for the small retail investor.

a variation of this technique is to step across the 30-day wash rule for capital gains at the turn of each tax year by buying a similar-performing company - or its options - while selling a losing stock for a taxable loss.

sorry i don't know anything about the US rules you are mentioning in your final paragraph, so wish to affirm that the above strategies are strictly for canadian market.

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## Park (Sep 11, 2010)

humble_pie said:


> a variation of this technique is to step across the 30-day wash rule for capital gains at the turn of each tax year by buying a similar-performing company - or its options - while selling a losing stock for a taxable loss.


Thanks for the response.

Once again, assume that next year is a lower tax year and you're concerned that the stock will decline in value prior to the next tax year. You can use the strategy I mentioned in the OP. I have heard of buying an out of the money put on your stock that will expire in the next year. You can finance the out of the money put by selling an out of the money call (a collar).

In the quote above, it sounds like you're proposing another strategy. One waits until the end of the year, and if there is a taxable loss, sell the stock and buy a similar performing company or its options. You've tax loss harvested and gotten around the 30 day wash rule.

Is that correct?


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## Rusty O'Toole (Feb 1, 2012)

If you wish to defer selling for tax purposes but are afraid of a drop in price you could buy a put.


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## Market Lost (Jul 27, 2016)

Park said:


> horting against the box involves shorting a stock that you already own. If you have an unrealized capital gain on the stock, you can lock in that gain until the short position is covered. So you can defer tax until the short position is closed out. If you will be in a lower tax bracket next year, but are concerned that the stock will decline in price in the short term, shorting against the box might result in a tax saving.
> 
> Shorting against the box for tax planning isn't allowed in the US. I've found it difficult to get information about Canada, but it looks like the same.
> 
> ...


It's not a simple answer because in general, shorting is considered an ordinary gain or loss, unless you make an election under s. 39(4), which cannot be rescinded in the future. What further complicates it is that if you are doing something this advanced, you could be considered a trader, in which case you cannot make the election. So as they say, you pays your money, you take your chances.


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## humble_pie (Jun 7, 2009)

Park said:


> Once again, assume that next year is a lower tax year and you're concerned that the stock will decline in value prior to the next tax year. You can use the strategy I mentioned in the OP. I have heard of buying an out of the money put on your stock that will expire in the next year. You can finance the out of the money put by selling an out of the money call (a collar).



alas option pricing these days does not permit anything so attractive. The OTM call you mention selling will fetch zilch while the cost of the at-the-money put to be bought will be high. If one would be buying a far OTM put, one will have already realized a considerable loss from today's stock price on that future date when one comes to exercise this protective put.

generally in a collar one looks for the strike prices to be the same, or at worst one increment apart.

there was a skilled collar trader in cmf forum a while back, his collaring was classic, exactly what the funds do in order to obtain an almost-guaranteed rate of return from an underlying dividend that is better than treasury bills. 

our friend was collaring to protect his dividend in BCE. Even then, to break even he had to buy puts one increment below the call strikes, so there was always a $2 loss exposure.

the catch here is that the underlying company might just up & cut its dividend. This is less of a risk in something like BCE, but has been a risk with many companies that previously paid high dividends. One is left with a beautiful collar but alas there is no longer much wearable shirt still attached to the elegant neckpiece.





> ... another strategy. One waits until the end of the year, and if there is a taxable loss, sell the stock and buy a similar performing company or its options. You've tax loss harvested and gotten around the 30 day wash rule. Is that correct?


yes. This is what the Mawer tax-advantaged balanced fund does. Which is why it holds individual stocks instead of blocks of other Mawer funds, as does the plain Mawer balanced.

when buying the substitute company or its options, one wants to make sure one does not already hold this company, because if one already holds then one would be disturbing its cost base by adding. That being said, this strategy can sometimes be a good idea, the point is to just Be Aware of possible tax consequences when buying the substitute.



lastly, Rusty has mentioned buying plain puts. This would also work. Its drawback imho is that it's a very expensive strategy ... check out the cost of buying puts in the individual stock whose price you might want to protect & chances are you will wince. 

it's my understanding some folks will buy SPY puts or XIU puts or both in order to insure their entire portfolios on the downside. This is said to be a cheaper route to go, if one fears lower prices in 2017 but doesn't want to take taxable gains in 2016.

the don't-short-the-box rule dates back to the US securities act of 1934, in the heart of the depression. Folks had been shorting the box so extensively that US banks were hurting badly, thus the act included the article that would block the box forever. Canadian securities legislation soon followed.

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## Rusty O'Toole (Feb 1, 2012)

You can buy an in the money put with a delta of around 70. This is an expensive put but most of the cost is intrinsic value. You don't lose intrinsic value unless the stock goes up, and then the loss is offset by the gain in the underlying stock. The down side is you make nothing on the rise unless it is fairly substantial but you are protected against loss to the down side. In this scenario you might set things up so your max loss in the worst case is no more than 5% while your upside is unlimited if the stock rises beyond your put strike.


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## Park (Sep 11, 2010)

Assume that next year is a low tax year, and you're concerned that your stock/ETF will decline in price prior to next year. Sell a future on your stock, with the expiry date of the future being next year. This is the equivalent of shorting against the box.

There are several issues here. First of all, most futures are for 3 months, although some of the more liquid ones might be tradeable at more than 3 months. Also, there has to be a future on the stock/ETF that you own, and its liquidity has to be sufficient to make this feasilble. Finally, can you sell a future on the same stock that you own, or does the CRA consider this the equivalent of shorting against the box? One way around this would be sell a future on a similar stock/ETF


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## humble_pie (Jun 7, 2009)

Rusty O'Toole said:


> You can buy an in the money put with a delta of around 70. This is an expensive put but most of the cost is intrinsic value ... In this scenario you might set things up so your max loss in the worst case is no more than 5% while your upside is unlimited if the stock rises beyond your put strike.




rusty you have a good point in theory re protective puts for individual stocks.

but let's look at one practical example in reality. Let's take RY on canadian exchanges.

stock this am is is 81.15. The 80P of january 2017 is 2.62-2.82. This cost - 2.82 - is 3.48% of 81.15 plus it already implies a capital loss of 1.15, for an additional loss of 1.42%.

the total cost of maintaining an 80P on RY today, for one brief quarter of the year only, is 4.63% of the money involved. This cost is far greater than the current dividend yield.

if one annualizes by multiplying the put cost X 4 quarterly purchases - because puts in a put-protected portfolio have to be permanently maintained - the cost of maintaining an $80 protective put in RY across 2017 works out to more than 14% of the stock's value today. 

this cost makes put "insurance" insanely expensive. Once we get into numbers like that, the Go is No.

PS one cannot buy a cheap put that is too deep OTM because it bakes too big of a loss into the transaction when exercised.


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## Market Lost (Jul 27, 2016)

Park said:


> Assume that next year is a low tax year, and you're concerned that your stock/ETF will decline in price prior to next year. Sell a future on your stock, with the expiry date of the future being next year. This is the equivalent of shorting against the box.
> 
> There are several issues here. First of all, most futures are for 3 months, although some of the more liquid ones might be tradeable at more than 3 months. Also, there has to be a future on the stock/ETF that you own, and its liquidity has to be sufficient to make this feasilble. Finally, can you sell a future on the same stock that you own, or does the CRA consider this the equivalent of shorting against the box? One way around this would be sell a future on a similar stock/ETF


Not true. All stocks with options have at least 4 contract periods within the year. Then you have leaps on top of that.

You should read what I already wrote about shorting, this includes options. The only exception is covered calls can be applied to your ACB.


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