Why Do Investors Short Stocks They Own?

Short selling is a trading strategy where an investor borrows shares, sells them on the market, and later repurchases them at a lower price to return to the lender, profiting from the price decline.

If you are looking to invest as an expat or high-net-worth individual, which is what I specialize in, you can email me (advice@adamfayed.com) or WhatsApp (+44-7393-450-837).

This includes if you are looking for a second opinion or alternative investments.

Some facts might change from the time of writing, and nothing written here is financial, legal, tax, or any other kind of individual advice, or a solicitation to invest.

Typically, investors short stocks they do not own when they expect the stock price to drop.

However, an older and now largely obsolete strategy, known as “shorting against the box,” involved shorting a stock while also owning it.

Why do investors short stocks they own?

At first glance, this seems contradictory—why would an investor bet against their own holdings?

Historically, this strategy was used to defer capital gains taxes, hedge against market volatility, and manage portfolio risk.

However, due to regulatory changes, tax law updates primarily led by the US, and more efficient hedging methods, shorting a stock you already own no longer serves its original purpose in most major financial markets.

This article will explore how shorting a stock you own works, why investors used to do it, and why it has largely fallen out of use in modern markets.

How does short selling work when you own the stock?

Shorting a stock that an investor already owns historically involved a strategy called “shorting against the box.”

This meant simultaneously holding a long position (owning the stock) and opening a short position (borrowing and selling the same stock). The result was a neutralized exposure to price movements, meaning no gains or losses from the stock’s price fluctuations.

How do you short stocks?

To understand how this strategy worked, let’s first break down traditional short selling:

• Borrowing Shares – The investor borrows shares from a broker, typically through a margin account.
• Selling the Borrowed Shares – The investor sells the borrowed shares at the current market price.
• Repurchasing the Shares Later – If the stock price drops, they buy back the shares at a lower price and return them to the broker, keeping the difference as profit.
• Covering the Short Position – If the stock price rises, they incur a loss instead.

Now, when an investor already owns the stock and shorts it simultaneously, the situation changes. The long position and the short position cancel each other out, meaning that any price movement in the stock results in neither a profit nor a loss.

For example:

• An investor owns 1,000 shares of Company X at $50 per share.
• They short 1,000 shares of Company X at $50.
• If the price drops to $40, they gain $10 per share on the short position, but they also lose $10 per share on the long position—resulting in zero net profit.
• If the price rises to $60, they lose $10 per share on the short position but gain $10 per share on the long position—again, zero net profit.

This means that shorting a stock you already own does not generate a profit from a decline in price, unlike regular short selling. The entire point of the strategy was to “lock in” gains or losses without exiting the position outright.

Is shorting against the box illegal?

In the US, yes. Shorting against the box is considered illegal for tax avoidance purposes under the Taxpayer Relief Act of 1997, meaning that if you attempt to use this strategy to defer capital gains taxes, it will be considered a taxable event and you could face penalties.

Before 1997, U.S. investors used shorting against the box to defer capital gains taxes. Instead of selling shares and triggering a taxable event, investors could short the stock they owned, effectively locking in gains without officially selling.

They could then close the position in a later tax year, deferring the capital gains tax liability.

However, the Taxpayer Relief Act of 1997 closed this loophole. The IRS now considers shorting against the box a “constructive sale,” meaning unrealized gains are taxed as if the investor had sold the stock outright. This effectively eliminated the tax benefit that once made this strategy attractive.

Today, investors in the U.S. can no longer use this method to defer capital gains taxes, making the strategy largely obsolete as a tax-deferral tool.

It still exists today in certain specialized contexts, particularly among institutional investors in other countries, however.

Why do some investors still short stocks they own?

Although tax deferral is no longer a valid reason, some institutional investors and hedge funds still engage in this practice for hedging, arbitrage, or regulatory compliance reasons.

• Hedging Against a Temporary Drop – Some investors want to temporarily neutralize risk without selling their shares. However, put options are now a more efficient way to hedge exposure, so this use case is rare.

• Regulatory or Compliance Requirements – Some funds short stocks they own to meet regulatory portfolio requirements. This is more common among large institutional investors rather than retail traders.

• Arbitrage & Market Inefficiencies – In rare cases, investors may short their own stock to exploit temporary price discrepancies between different stock classes or exchanges.

Even in these scenarios, shorting against the box has largely been replaced by more efficient financial instruments, such as options, swaps, and synthetic positions.

Brokerage & Regulatory Restrictions

Most brokers do not allow retail investors to short against the box because:

• It offers no economic benefit—any gains in one position are canceled by losses in the other.
• It ties up capital unnecessarily due to margin requirements and borrowing fees.
• Regulatory oversight requires disclosure in some jurisdictions when an investor holds both a long and short position in the same stock.

Because of these limitations, many brokers simply do not permit this type of trade anymore.

Modern Alternative Hedging Strategies

With shorting against the box now largely obsolete due to regulatory restrictions and tax law changes, investors seeking risk management solutions have turned to more efficient hedging strategies.

These modern alternatives allow investors to protect their portfolios, hedge against declines, and manage capital gains exposure—without the drawbacks of shorting a stock they own.

Below are some of the most effective hedging strategies used today.

Buying Put Options: A Cost-Effective Hedge

One of the most common and efficient ways to hedge a stock position is buying put options. A put option gives the investor the right (but not the obligation) to sell a stock at a predetermined price (strike price) before the option expires.

If the stock declines, the put option increases in value, offsetting the losses from the long position.

Example:

An investor owns 1,000 shares of Company X at $100 per share. They buy put options with a $95 strike price expiring in three months. If the stock drops to $80, the put option gains value, offsetting the losses from the long position. If the stock price rises, the put expires worthless, but the investor still benefits from holding the stock.

This makes put options a preferred method for investors who want to protect against short-term volatility without giving up long-term stock ownership.

Protective Collars: A Low-Cost Hedging Strategy

A protective collar is a strategy that combines buying a put option with selling a covered call option. This allows investors to hedge downside risk at a lower cost than simply buying a put option.

• Buy a put option to protect against a stock price decline.
• Sell a call option to generate premium income, helping offset the cost of the put.
• The trade-off: The investor caps their upside potential, meaning if the stock price rises significantly, the call option limits their gains.

This strategy is commonly used by long-term investors who want downside protection without fully exiting their position.

Diversification as a Hedging Tool

Rather than shorting individual stocks, many investors hedge risk by diversifying their portfolios across different asset classes and sectors. This approach reduces exposure to any single stock or market downturn.

• Sector diversification – Holding stocks in different industries (e.g., technology, healthcare, consumer goods) reduces reliance on a single sector.

• Geographic diversification – Investing in international markets helps hedge against country-specific risks.

• Asset class diversification – Adding bonds, commodities, and alternative investments provides natural hedges against stock market downturns.

For most long-term investors, proper diversification is often the best and simplest hedge against market volatility.

Inverse ETFs: A Hedge Against Market Declines

Inverse Exchange-Traded Funds (inverse ETFs) are designed to move in the opposite direction of a specific stock index. Investors can use these funds to hedge against market downturns without shorting individual stocks.

For example:

• SPXS (Direxion Daily S&P 500 Bear 3X Shares) moves opposite to the S&P 500.
• SQQQ (ProShares UltraPro Short QQQ) moves opposite to the Nasdaq 100.

While not a perfect hedge, inverse ETFs offer a way to bet against the market without needing a margin account or options trading approval.

Selling Covered Calls: A Conservative Income Hedge

If an investor expects moderate downside risk but does not want to fully hedge their stock, they can sell covered call options against their long position.

• A covered call involves selling a call option on stock the investor already owns.
• The investor collects a premium from the call option, providing income that offsets potential losses if the stock declines.
• However, if the stock price rises sharply, the investor may have to sell their shares at the call’s strike price, limiting their upside.

Covered calls are a good strategy for hedging mild volatility while still collecting income but are not a strong hedge for severe price drops.

For more thorough guidance, please seek the services of a financial planner.

Pained by financial indecision?

Adam is an internationally recognised author on financial matters with over 830million answer views on Quora, a widely sold book on Amazon, and a contributor on Forbes.