How to Bet Against the Stock Market Going Down - Financhill

How to Bet Against the Stock Market Going Down

How to Bet Against the Stock Market Going Down: While the economy is expected to continue growing throughout this year, it won’t be steady and across the board. The Chicago Fed estimates growth has been decelerating since 2018, and the country’s GDP is only expected to grow by 1.9% in 2020.

In some markets, like cryptocurrency, the exponential price growth of Bitcoin from $100 to nearly $20,000 back down below $10,000 has many losing their shirts while others buy lambos. Many still believe it’ll grow to $100,000 or even $1 million.

Surviving the Great Depression of the 1930s was hard, and the 2008 foreclosure crisis was no walk in the park, either. From Countrywide to Worldcom, Enron and Theranos, history has consistently proven that no investment is safe.

It’s all about timing, and being a wolf on Wall Street requires successfully navigating bears and bulls. If you buy low and sell high, you’ll win – everyone knows that.

Of course, the stock market is a lot more complicated than that, and many people find ways to bet against the market and make money off others’ losses. It’s the opposite of conventional wisdom, but it works. That’s because every upturn in the market eventually becomes a downturn.

All you need is a firm understanding of which investments go up when the market goes down. Let’s dive in.

Buy A Put Option on SPY or DIA

Put options are a little different than stocks, and options trading is the next skill to learn once you understand how to ride the market’s volatility.

A put option is the right to sell an asset within a certain timeframe for a specified price without the obligation to do so. Thus, it’s an “option,” and it’s used for stocks, bonds, currencies, indices, and other investments within your portfolio.

You can also use a put option against entire markets. This is useful if you’re insuring your net worth against a collapsing economy. If you’re betting against a market crash, there are two put options in the form of Exchange-Traded Funds (ETF) on stock markets.

1. SDPR S&P 500 Trust ETF (SPY)

Formerly known as Standards & Poor’s Depository Receipts, the SPDR S&P 500 trust is an ETF that tracks the S&P 500 stock index. It’s one of the most followed indices in the U.S., because it provides a representation of the overall market. Investors from Warren Buffet to John Bogle use the S&P 500 to recommend investments.

The components of this index are selected by committee based on minimum requirements of $8.2 billion market capitalization, an annual dollar value trading to float-adjusted market capitalization ratio above 1.0, and 250,000 shares traded each of the six months prior to evaluation.

2. SPDR Dow Jones Industrial Average ETF (DIA)

Launched in 1998, this ETF is known for replicating the Dow’s market performance. This index of 30 large companies differs from S&P in that it doesn’t replicate the market.

Instead, it’s focused on cherry-picked large investments that cover specific industries. In the beginning, this included coal, utilities, commodities, and other heavy industries.

Today’s Dow includes a wide range of companies, including Johnson & Johnson, McDonald’s, Apple, Nike, Verizon, The Walt Disney Company, and Walmart. Should one of these major pillars face a problem, a put option will protect you.

With a put option on these ETFs, you’re locked into a price that won’t drop with either of these major market indices.

Short the Market

Short selling is a risky investment strategy, but it’s proven profitable for those with the appetite to use it. You may be familiar with the term due to the movie, The Big Short, which focused on three investors who shorted mortgage-backed securities waiting for an artificially inflated housing bubble to burst.

A short is a speculative bet on the future decline of a stock price. Had you shorted Bitcoin in 2018 when its price was collapsing from its artificial inflation, you would have made a mint when it dropped that extra weight.

To short the market, you borrow shares at a set price and repay with shares purchased at a future date. The lower the market goes, the more profit you make. However, as the stock market rises, you owe on a short, and your losses could be infinite. Can you imagine shorting Apple back in the 20th century and being hit with today’s prices?

Short selling requires a margin account with a stockbroker. When you place your order, the broker borrows the shares on your behalf and sells them, crediting the money to you. It’s held in escrow until later used to buy back the shares.

As the market closes each day, you’re responsible for paying any dividends against the borrowed shares. This means if you invest $100 and the price ends at $200, you need to pay $100. If you remember The Big Short, this is what was happening, and the investors of the funds shorting the housing market were not happy as the years went by.

Billionaire hedge fund manager Bill Ackman famously shorted Herbalife for $1 billion over the course of six years. In that time, Herbalife’s stock more than doubled from $45 to $95.

Like puts, shorts can apply to a single stock or market index. Also consider buying one of these ten stocks during a recession to secure your long-term financial security.

Sell Bearish Credit Spreads

Once you understand put options and shorts, you can work your way through a bearish credit spread. This is an intermediate investment strategy with more limited risk and reward compared to short sells. In this strategy you purchase both a long and short option at different prices.

These spreads contain your losses when the market starts to turn. It’s a great way to experiment with new investments you’re not familiar with. Bearish credit spreads give you a healthy range to work with when you’re not sure of exact values.

These limits are popularly used to mitigate damage when the market is losing steam. If the stock hits absolute zero, then you’ll pay a small portion to ensure your financial security.

In the above short examples, Ackman could have insured against some of his losses through spreads. In fact, he probably would’ve walked away with a slight gain. Meanwhile, the investment firms from The Big Short would’ve severely limited their profit potentials from betting against the failed mortgage-backed securities.

There’s one last bet against the stock market you can take.

Buy Inverse ETFs on Major Market Indices

The final strategy to bet against the market is an advanced one called inverse ETFs. An inverse ETF (e.g. DOG, DXD) is like a short in that you’re using derivatives to profit from the market’s decline. These derivatives are futures contracts that set a price or time to sell assets.

Instead of using a margin account, the inverse ETF focuses on the market index to hedge your bets against a loss. Buying an inverse ETF will have the same effect as a put option for a market index ETF above. They just take different routes to get there.

An investment portfolio containing inverse ETFs is set for short-term protection against market losses. In fact, it’s important to understand that all these investment opportunities are short-term stop-losses.

Betting against the stock market is not a long-term investment strategy that will get you to retirement. It’s an emergency pivot that’s used to limit your financial liability from losses. These strategies are also used by day traders for temporary situations.

Choosing between a spread, put, and short will depend on your market outlook and risk appetite. Whichever you choose, these investment strategies are options to consider for your overall investment portfolio. They limit your financial liability against losses, just like insurance.

When we face another inevitable market downturn, you’ll be glad you have them.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.

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