However, you can also take short positions against entire industries, and even the stock market as a whole. There are three standard ways to short the stock market. The first option, and by far the easiest for retail traders, is to buy what is known as an inverse fund. These are mutual funds and exchange-traded funds ETFs built to profit whenever the underlying index declines.
However, because they are inverse funds, they gain value when the stock market goes down, and lose value when the stock market goes up. Bear funds are generally built around underlying short sales and counter-cyclical assets. However, because you have bought these assets, they also come with far less risk to the investor than engaging in a direct short sale.
A second option is to short sell an ETF. You would choose ordinary index ETFs, not inverse ones. You cannot short sell an ordinary mutual fund. An options contract is, essentially, placing a bet on how the price of a given asset will change over time. Buying a put option gives you the right but not the obligation to sell a security at a certain price — the strike price — any time before a certain date.
This means you can require whoever sold you the put option — the writer — to pay you the strike price for the stock at any point before the time expires. Buying an inverse fund comes with the ordinary risks of investment. If your fund declines, you can potentially lose the money you have invested. However, taking a short position on any fund or stock, along with taking many put positions, comes with a far greater risk. Unlike with a long position, with a short position you can lose more money than you invested.
It is during these periods when the market is correcting lower that buying puts can be a powerful options strategy to preserve wealth accumulated during up days and even profit during the gloomy, down days. Some of the richest investors of all time have made fortunes by betting against the stock market, so you will definitely want to get to grips with how to win when markets fall.
You may not end up featured in a Hollywood movie like Michael Burry , who famously bet against the stock market and made a fortune during the crash. In a nutshell, a put is a contract that gives you the right to sell stock at a fixed price for a certain time period. For example, if you owned shares of Netflix stock and purchased a put option contract that expired 6 months from now, you would have the right to sell your stock at a fixed price anytime between now and then.
Even if Netflix crashed to zero during that time frame, you would still have the right to sell your stock for the agreed upon price! When traders believe a stock will fall lower, they can borrow shares and sell them with a view to buying them at lower prices later on. To bet against Alphabet stock , for example, you would short Alphabet at the current share price in the hopes that, when the price fell, you could buy it back buy-to-cover is the terminology used for a profit.
The kicker is if you are wrong, you risk losing a lot of money. In fact, the higher the share price goes the more you lose when shorting stock. So when making a choice between buying puts vs shorting stock, the former is often preferred because the risk is limited.
Investors frequently want to find ways to protect their assets from a crash without selling everything they have and going into cash or bonds. On days when the Dow falls over points, most investors wish they would have hedged with put options or selling out of some stocks ahead time.
Be advised that this is not a prediction of a stock market crash. In fact, defining a crash versus a sell-off is something that many investors cannot even agree upon. With no vaccines yet approved, and with some recent mixed reactions and halts in the Phase III studies, the hope of widespread vaccinations seems to be looking further out than had been hoped. Earnings from major companies are getting very mixed reactions from the market, with many major stocks falling even on great earnings.
Another issue is that the live economic reports are still showing mixed signals about the recovery. And to top it off, more civil unrest in some larger U. After a 3. The problem with a rising VIX is that it usually means that buying put option protection for the major indexes, or stocks or ETFs, usually becomes very expensive. Wednesday marked the highest closing price on the VIX since June 11, For a reminder in trading history, June 11 was also the day that the Dow fell more than 1, points about 6.
And while the market retested the lows again in June, it should at least be considered that those days were the lowest the markets have been since. And to add more fire, the Brexit negotiations are expected to run through mid-November. If that all is not enough, the U.
The problem there is that with massive drops in Europe and the U. Where this rapid decline in stocks that has been seen this last week gets tricky is in Treasury yields. Unlike mutual funds, which can have high investment minimums, investors can purchase as little as one share of an ETF at a time. Your money is indeed insured, but only against the unlikely event a brokerage firm or investment company goes under.
Your account choices boil down to a taxable brokerage account versus tax-favored retirement account, such as an IRA. And by that we mean taking a thoughtful and disciplined approach to investing your money for the long-term. Some key criteria to consider when evaluating any investment company are how much money you have, what type of assets you intend to buy, your trading style and technical needs, how frequently you plan to transact and how much service you need.
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