I have made it clear that I am an optimist. Although there have been many pessimists predicting the reverse, I strongly believe that stocks will rise and the world won’t end.
In fact, the S&P 500 has risen roughly 5% since I told you that everything would be okay (Aug. 30). I knew that Ben Bernanke would be tempted to intervene, but I wasn’t sure how much support he would be willing to give. To be exact, he has pledged to buy $40 Billion worth of mortgage-backed securities per month UNTIL THE ECONOMY IMPROVES <—keywords.
This came a week after the European Central Bank announced that they would gobble up government bonds to help with their debt crisis.
All in all, stock market returns have been good. Maybe too good.
How Can I Bet Against the Stock Market?
Now that stocks have already gained 15% this year, all the donks out there are finally thinking about “getting into the market.” As a contrarian investor, it may be time for you to get out – especially if you think the positivity is artificial.
So let’s say this is your mindset. How can you benefit from your instincts predicting a market decline?
You could sell everything to lock in your gains – OR – you could try to profit even more.
With a put option, you pay for the right (NOT OBLIGATION) to sell a specific stock at a specific price within a specific time frame. For example, if I think Amazon (trading 300x forward earnings) is going to go down, I could buy a Put Option that expires this month, next month, next year, or in a few years.
Shorting a Stock
I would only recommend this to less than 1% of investors. It can be both complex and risky. I’ll try to simplify it for you…
You borrow a stock. You sell the stock. Since the stock you sold is borrowed, you promise to buy the stock later to in order to repay your debt. If the stock went down, you may have sold it for $20 and bought it back for $15.
Khan Academy probably has the best video tutorial on shorting stock.
Inverse Exchange Traded Funds are extremely simple (unlike the above options). You can use them as a hedge or if you want to bet against the market. They differ from shorting and put options because they don’t involve individual stocks. Instead you can focus on the entire market or a specific index or commodity. Example: remember when Gold was skyrocketing and you knew it had nowhere to go but down? Depending on how confident you are, you can bet 1x, 2x or 3x the movements.
Readers: Do you have any additional tips on ways to bet against the stock market?