Learn How to Bet Against the Bond Market

Betting against the bond market with blue chips stacked on top of a bond certificate
•••

 Sandra Baker / Getty Images

There is no shortage of ways to invest in bonds, including mutual funds, exchange-traded funds (ETFs), and individual bonds, but how does one go about betting against the bond market? It’s a question many investors ask whenever talk of a “bubble” makes the rounds in the bond market.

There are different ways investors can go about shorting bonds, but be careful—the occasions when bonds fall in price for an extended period have been few and far between in recent decades. Betting against the market, therefore, requires a tolerance for risk, the ability to absorb a loss, and, perhaps most importantly, outstanding market timing.

Inverse Bond ETFs

The easiest way for individual investors to position for a downturn in bond prices is by using “inverse ETFs,” or exchange-traded funds that take short positions in bonds. Inverse ETFs rise in price when bond prices fall, and they decline in value when bond prices rise.

"Shorting"

A “short position” is when an investor sells a security they do not own, hoping to buy it back later at a lower price and thereby pocket the difference. In other words, it’s the technical term for “betting against."

The current crop of inverse bond ETFs provides investors with the ability to position for a downturn in U.S. Treasuries, Treasury Inflation-Protected Securities (TIPS), corporate bonds, high-yield bonds, and even Japanese government bonds. Investors can also choose ETFs that will rise two or three times the inverse of the daily performance of certain bond market segments. For instance, if the underlying investment fell by 1% on a given day, the two-times inverse ETF would rise by 2%. 

While these funds can provide short-term traders with opportunities, over time they tend to deliver performance far from their stated two-times or three-times objective.

For example, an inverse Treasury ETF might lose 2% if the market rises by 1%. Since bond markets have historically risen over time, the risk of losses with an inverse Treasury ETFs increases over longer timelines. This is only a hypothetical, but it illustrates the divergence that can occur over time. This is the most important reason why the leveraged inverse funds shouldn’t be considered long-term investments. In short, be wary—these ETFs are high-risk in nature, and losses can mount quickly if you bet wrong.

Mutual Funds

Investors also have the option of investing in mutual funds that move inversely to the bond market, such as the Guggenheim Inverse Government Long Bond Strategy (ticker: RYAQX) or the ProFunds Rising Rates Opportunity ProFund (ticker: RRPIX). While both funds accomplish the same goal as the ETFs mentioned above, using a mutual fund instead of an ETF deprives investors of the opportunity to buy or sell the fund at any point during the trading day. Instead, transactions are only allowed once a day at a set, closing price. The two funds also carry hefty expense ratios (4.4% and 1.5%, respectively), while ETF alternatives usually come with lower expense ratios.

Selling ETFs Short

Instead of investing in ETFs that short bonds, investors whose brokerage accounts allow them to use margin can also conduct their own short sales using ETFs that take long positions on the bond market.

If the shares fall in price after an investor enters into a short position on an ETF, the investor can buy shares back at a lower price, thereby pocketing the difference. However, if the shares rise, the investor must buy the shares at a higher price than they originally shorted them, incurring a loss. By selling a fund short, the investor can generate returns that are the opposite of the performance of the ETF.

The benefit of doing a short-sale with a long fund, rather than simply buying an inverse ETF, is that the investors' realized return will track more closely to the actual inverse performance of the underlying investment. Inverse ETFs only deliver the expected return in single calendar days—over longer periods their returns deviate significantly from the result an investor might anticipate based on the fund’s objective.

Futures and Options

This is the realm of the most sophisticated investors with the greatest ability to absorb a loss. In other words, this strategy is best reserved for investors with extensive experience and plenty of wealth to bet on risky positions. For those who hold an account with a commodity futures broker, it’s possible to trade futures contracts on Treasury bonds and notes of varying maturities. As with a stock or an ETF, an investor can sell a bond contract short in the hopes that its price will fall. The risks are substantial—small moves in the underlying security are magnified significantly in the movement of the related futures contract.

It’s also possible for individual investors to buy options contracts—or more specifically, bearish puts—on bond ETFs that have options available. Options trade on the major bond ETFs, such as those that hold Treasuries, corporate, and high yield bonds, so there is a way to use options to play the direction of all of the important segments of the bond market.

Keep in mind, options require investors to correctly bet the direction of the underlying security, while also nailing the timing of such a move. That's part of what makes options extremely risky. Options can—and regularly do—go to zero and saddle unfortunate traders with 100% losses. Suffice it to say, this is the “deep end of the pool,” and not an area in which novice investors should try to make money.

Hedging Your Portfolio

Betting against the market is unlikely to work over the long term, but it can provide investors with a way to “hedge” their portfolios, or, in other words, to protect against short-term losses. For example, someone with a $100,000 bond portfolio could take a short-term, $50,000 position in inverse ETFs—or any other investment that moves in the opposite direction of the market—to limit the impact of a market downturn.

The problem with this strategy is that, if the investor is wrong and the market does not go down, the hedge itself loses money and takes away from the long-term wealth accumulation that the investor is (presumably) trying to accomplish. That makes this another type of move that should only be considered by the most sophisticated investors.

The Bottom Line

There’s no shortage of ways that an investor can attempt to profit from a downturn in the bond market, and many veteran investors do indeed use these techniques profitably. But for the majority of investors, the road to wealth is well-known: diversify, stay focused on your long-term goals, and stay away from high-risk strategies. If you are considering a way to profit from market weakness, be sure you understand the risks of such a move.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.