When people think about investing, they usually think about buying stocks, mutual funds, or exchange-traded funds (ETFs), hoping they will increase in value. If they do, you can sell your shares for a higher price and earn a profit, but if the shares lose value, you’ll lose money.
For investors who think the stock market is poised to fall, there are ways to profit from betting against the market. This gives investors an opportunity to profit from both up and down markets.
This article will cover some of the most basic ways to bet against the market. There are many methods to profit in a downward market, but these are some of the easiest ways to get started.
- Betting against the market means investing in a way that turns a profit when the stock market falls.
- If the stock market rises, you’ll lose money by betting against the market.
- You can bet against the market by using options or with specialized mutual funds and ETFs.
What Is Betting Against the Market?
Betting against the market means investing in a way that you’ll earn money if the stock market, or a specific security, loses value. It’s the opposite of buying shares in a security, which in effect is a bet that the security will gain value.
Short selling is one of the most common ways to bet against a stock. To short sell a stock, you borrow shares from someone and sell those shares immediately, with the promise that you’ll return the shares to the person you borrowed them from at a future date.
If the price of the shares falls between the time you sold them and the date you have to return those shares, you can buy the shares back at a lower price and keep the difference. If the price rises, you’ll have to pay extra out of pocket, losing money.
Typically, short sellers borrow stocks from their brokerage, and the brokerage automatically takes money from the investor’s account to repay the loan.
There are many other ways to bet against the market, some more complicated than others. These are some of the most common options.
Buy an Inverse Fund or Bear Fund
Some mutual funds and ETFs advertise themselves as inverse funds or bear funds. These funds work like any other mutual fund, letting individual investors buy shares, and tasking the fund managers with building and maintaining the portfolio.
But the goal of a bear fund is to gain value when the market drops. Typically, fund managers do this using derivatives like swaps. If you buy a Standard & Poor’s 500 bear fund and the S&P 500 loses 10% of its value, the bear fund should gain about 10%.
These funds tend to be one of the less risky ways to bet against the market because they are not overly complex and don’t involve leverage.
One thing to keep in mind, though, is that these funds tend to be more expensive to operate than more typical funds that hold shares in businesses. This is because of the additional costs and management associated with the derivatives that are required to produce a positive return in a downward market. Also recall that historically, the market tends to rise over time, meaning you won’t want to hold these funds for the long term.
Buying a Put
A put is an option that gives the holder the right, but not the obligation, to sell shares in a security at a set price (called the strike price) at any time before the expiration date. For example, you might buy a put that gives you the right to sell shares in XYZ at $35 any time between the day you purchase it and June 30.
When you buy a put, you have to pay a premium to the put seller. The premium you pay is the most you could lose from the transaction. If you don’t exercise the option, you’ll lose the premium and earn no money.
In the example above, if the price of XYZ stock falls below $35, you can exercise the option and earn a profit. You’ll buy shares on the open market at the current market value, then sell them for $35 each.
Most options are for 100 shares, so the formula for calculating your profit from buying a put is:
((Strike Price - Market Price) * 100) - Premium Paid = Profit
So, if you paid a premium of $65 for the option and shares fall in value to $30, you’d earn:
(($35 - $30) * 100) - $65 = $435
Buying puts is betting against the market because they become more valuable as the price of the share falls farther below the strike price of the option.
Futures are a related concept. Futures contracts obligate two parties to conduct a transaction at a specified date in the future. This is in contrast to options, which are optional to exercise.
You can bet against the market with futures by signing a contract agreeing to sell a security below its current value. If it falls below the strike price of the contract when the future is exercised, you’ll turn a profit.
Short Sell an ETF
ETFs are like mutual funds in that they are investment vehicles that own shares in dozens or hundreds of other securities. They let investors buy shares in a single security, the ETF, to quickly and easily build a diversified portfolio.
There are ETFs focused on specific market indexes, the market as a whole, or individual industries. You can short sell ETFs to bet against specific sectors or the market as a whole. To do this, you’ll want to short sell an index ETF or an ETF focused on a specific index.
A benefit of short selling ETFs is that you diversify your short exposure, making it less risky than short selling a single stock. It can also be cheaper than paying the management fees for investing in bear ETFs.
The drawback is that short selling has potentially infinite risk, as the price of the ETF can rise infinitely, in theory. Some ETFs also don’t have sufficient liquidity available to make short selling effective, so you’ll want to choose a popular ETF when short selling.
Frequently Asked Questions (FAQs)
What is the best ETF to short the market?
There are many different ETFs that let you short the stock market. One of the most popular is the Pro Shares Short S&P 500 ETF, which “seeks a return that is -1x the return of its underlying benchmark.” Meaning, if the S&P loses 1% of its value, this fund aims to gain 1%.
What is the best way to short the market?
There is no single best way to short the market. Which strategy you prefer will depend on your investment goals and risk tolerance. For example, bear ETFs are simple to use, which makes them popular. However, short selling or using derivatives instead can let you leverage your portfolio, increasing your risk but also increasing potential rewards.
Is buying a put the same as shorting?
Buying a put is one of the many ways to bet against a stock or other security. Sometimes, betting against a security is colloquially referred to as “shorting” it. However, buying a put is different from a short sale, another way to bet against a stock. Short selling involves selling shares you do not own by borrowing them from someone and intending to buy those shares later to return them to your lender.
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.