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How to Short the Market?

Contributed by mm | February 6, 2004 10:14 PM PST

One of my favorite personal finance columnist Whitney Tilson provided this good summary of various tools to short the market.

Leverage Inverse Fund

They are the mutual funds that will behave inversely to the market direction. Whitney actually discussed one of such funds, Rydex Venture 100 Fund (RYVNX) long ago (I blogged here). It looks like a bad idea now -- while the fund always displays contrary returns to the market every day, Whitney noticed that over a period of time it cannot actually reach its goal.

Shorting Market Index ETF, Like QQQ

This option is evident, and the shortcoming is potential losses are theoretically infinite.

Credit-Default Swaps (CDS)

CDS is an option that offloads default risk of underlying bonds to the option writers. Essentially, you purchase CDS to bet that the underlying company will default on its debt. Whitney thinks with the turbulent future of the financial market (in my opinion, thanks to the irresponsible Fed budget and Fed's monetary policies), some heavily leveraged companies may fall. (Whitney offers a list of such companies in this post. These companies are: ABK, PMI, MTG, RDN and XL.)

There is no liquid market for CDS so it may not be a good option for individual investors.

Puts

This is to purchase options to benefit from a market call. Any potential loss is limited, and gain is unlimited. This is literally a leveraged way to bet on index -- volatility is much higher than shorting QQQ and alike.

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