A reader, Seth, asked the following question about taking a bearish position in the market:
“I read your article on leaky leveraged ETFs. I have invested less in these products in the volatile markets. Other than put options or shorting a stock like the SPY (risk of call back and paying out dividend disbursements), do you know of other ways to take a bearish position on the indexes? Are all bear ETFs calculated on compounded daily percent?”
There are other ways to bet against the market, including selling call options and investing in bear funds, but I can’t recommend them. Selling naked calls on the hunch that the market may be going down can lead to big losses if you’re wrong, and the various bear funds don’t perform well on average through all types of markets.
All the bear ETFs I’ve looked at rebalance daily and suffer from volatility losses. The bear funds I’ve seen try to make money by picking individual stocks that they expect to drop in price. These funds don’t rebalance daily, but they must rebalance once in a while or else just one bad pick could sink the whole portfolio. It is less obvious with these funds, but they suffer from volatility losses as well.
All methods of betting against the market will suffer from the problem that the market tends to go up. As an example, if the market tends to go up by 10% per year, those who short the index will underperform a long position by 20% in an average year. This built-in bias to go up means that you have to be right about your guess that the market will drop a very high fraction of the time to come out further ahead than a simple buy-and-hold long position.
I know I can’t guess market directions well enough to win at this game. I invite other readers who know of ways of betting against the market other than those already mentioned to comment. However, I’ll be shocked if any of them don’t suffer from the problem that the market tends to go up.
Sure, just use zone theory to identify bad months, buy the bear ETF at the start of the month and sell at the end. I've back-tested this strategy and it's a sure-fire winner.
ReplyDeletePatrick: Thanks for the chuckle. I had fun making up that April Fools post on zone theory.
ReplyDeleteHeh. I guess what I'm trying to say is that bear ETFs are not meant as investments. They're meant as hedges. The only way to make money in a bear ETF is market timing. And I know how we both feel about market timing.
ReplyDeleteMichael,
ReplyDeleteWhen people buy stocks, they are seldom warned that 'bear markets can hurt.'
I don't think it's fair to reply that 'markets tend to go up.' This person wants to make a bearish play.
To go short:
1) Sell call spreads. You are correct, not naked calls.
2) Buy put spreads
3) If you already own stocks and don't want to dump them, buy a cheap collar: sell a call and buy a put
4) Sell shares short. I cannot foresee any risk of being forced to buy in SPY shares - but check with your broker to see if shares are available for you to borrow. And find out if there is any cost to borrowing the shares.
5) If you understand options, you can buy an inexpensive, out of the money put butterfly. If the underlying drops, the butterfly will widen
There are many reasonable ways to go short. But I'd like to issue one warning. If you are near fully invested now, instead of making a direct bearish play, just sell some of your longs.