We’re all seeing a lot of red these days. Red on our screens from our portfolios hemorrhaging capital and seeing red figuratively from the anger and frustration that has accompanied the downturn of the past several months. Things don’t look to be abating anytime soon, so during times like these investors need to have a strategy for operating in a period of downward volatility.
For those that think there is still room to go on the downside, using ETFs to play the market as a whole can work well since they don’t rely on picking out particular hairy dogs and betting on them to be beaten down. Shorting QQQ for the Nasdaq 100 and SPY for the S&P 500 can be the most straightforward way to make a downside bet, but shorting carries risk since (in theory) the target of the short can only go to zero, where the upside is unlimited.
Using options can provide investors a way to get net short the markets but with limited risk. Buying put options on QQQ and SPY provides a way to profit off sinking markets and allows investors to specify the time period they want to have the position. The longer the timeframe, the higher the price, however. Selling calls can have the same effect but with an income kicker, as the seller collects the call premium and hopes for the market to remain neutral or head lower. If the market rises though, the call seller will lose money.
Shorting, buying puts, and selling calls on individual stocks and/or industry sectors are a narrower way to bet on future downside. For example, every time I find myself in an airport the temptation is great to short the JETS airline sector ETF since that industry is simply incapable of operating at consistently profitable levels but offsets that dismal financial performance with horrendous customer service.
Inverse ETFs are another way to bet on red arrows continuing and can be either unleveraged or leveraged, depending on how aggressive the investor wants to be. Inverse ETFs achieve their goal by utilizing swaps and other financial instruments to create a short position and carry greater risks than traditional ETFs due to daily calculations of Net Asset Value. Investors must read the prospectus very carefully if they are considering one of these products, as in some cases they are designed for daily bets, and not designed to be held for long periods. Some examples of inverse ETFs are SH, which shorts the S&P 500, PSQ, which shorts the Nasdaq 100, and DOG, which shorts the Dow Jones Industrial Average.
If investors have lost their appetite for simply buying the dip during a market downturn, they have several ways to bet on further selling. Shorting stocks and ETFs, utilizing options both as a buyer and seller, and inverse ETFs can all be arrows in the quiver for bears who believe the screens will stay red for a while longer.
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