<<Also what are the other benefits of shorting against the box?
I have heard that it can be used to circumvent the uptick
rule. How is this done? Any explanation would be appreciated.>>
I'll tackle this part of your post. Actually, I won't address the usual benefits (e.g.to postpone capital gains, etc), but instead I'll concentrate on two strategies that are of particular interest to bears, indeed two aspects that aren't too often discussed.
Shorting against the box doesn't actually let you circumvent the uptick rule, at least that may not be the best way to think about it. Let's say you're involved with a highly volatile stock which, for whatever reason, you think you will have difficulty shorting. What you can do is short the stock whenever the shares become available and then box the position with a corresponding long position. Then you just bide your time until you decide to go short.
So, first scenario- (1) Pretend you've waited days to borrow shares to short Zitel by having been placed on a waiting list. Finally your broker calls you and says he's russelled up 1K shares for you to short at your heart's content, but here's the catch: you only have the shares for the day- if you don't use them by that time, you loose them. However, over the course of the several days wait the shares have fallen past your ideal entry point. Yet you expect there to be a pop back up in the shares in the next few day's, and by gosh, that would be the perfect time to short since in the long term you think the stock is going to go down. So, short the 1K shares, buy 1K shares long (tell your broker wjhat you are doing so your short doesn't get covered)- now wait the few days for the shares to rise up several points, like you expected, then sell the long position, and wait for the shares to go down when you then cover your short sale with a new purchase of 1K shares. Sounds great in theory, but obviously extraordinarily difficult to time just right.
Now, scenario (2) Say you've got a fast moving, volatile stock you want to short- this time the problem isn't that you had a tough time borrowing shares- no, au contraire, they're darn right easy to borrow. But now say there's a news event coming up- let's take Cephalon, for instance, last week- let's say you didn't expect CEPH to get FDA approval for its drug for Lou Gherigs disease, and that you expected the stock to plummet hard as a reult of the news (asin fact it did), but you weren't sure this was going to happen. On the one hand, you could wait for the news that it failed and then try and short it, but it would be highly unlikely that you would get an uptick to place your short before the stock plummetted too far- on the other hand, you weren't entirely sure that CEPH would fail the FDA review, and you wanted to protect yourself in case you were wrong. Here is another time you might use a box- if CEPH fails to pass the review (as it did) you would sell your long as quickly as practical and then cover your short when you thought appropriate- if CEPH did pass review the stock would shoot up, but then all you would have to do is to tell your broker to journal your account so that your long position covers your short. Again, this sounds great, but how it works in theory is an entirely different matter.
The disadvantages of boxing your position is the double commissions and the fact that you chew up a lot of capital (or margin) by maintaining such a balanced position.
Hope this helps, and I'll be interested in hearing from other people on their views on this matter.
Anaxagoras |
