Investing in the S&P 500 has been a reliable way to grow and diversify our portfolio. Many investors use it as a benchmark while some traders like to short it but what does it mean to short the S&P 500?
We know that shorting the S&P 500 sounds so technical and can be daunting to beginners. That’s why we prepared this guide to provide a brief walk-through of the steps and considerations you’ll need before you short sell the S&P 500 index.
So don’t stress yourself out and never be afraid to learn and take some risks. We’ll provide an overview of the basics of shorting the most popular index in the world and explain the risks and rewards of this trading strategy.
What is Shorting the S&P 500?
Shorting the S&P 500 is a technical stock market strategy where investors borrow shares of the S&P 500 index and sell them in the hopes that the stock price will go down. If the stock price does indeed go down, the investor can then buy back the shares at a lower price, pocketing the difference as a profit.
Benefits of Shorting the S&P 500
Profit when the market is down
One of the advantages of shorting the most popular index is the potential to profit even when the stock market is going down. A lot of active traders shorted the S&P 500 index when the market crash during the pandemic and severe market volatility.
Hedge your portfolio
While the S&P 500 offers an excellent way of diversification by investing in 500 US blue chip stocks, short selling a position of the S&P 500 can be a technique of hedging your portfolio. If you’re invested in a particular stock and you’re worried about losing its value when the market goes bullish, you can short the top index to offset any losses you might incur from the stock.
Learn technical skills
Taking a short position is one of the most challenging and technical trading skills. When you short the market, you learn and experience its risks and rewards and the strategies to execute your trades, you can become a successful trader.
Things to Consider Before You Short the S&P 500 Index
Shorting or short selling can be a very profitable strategy, but it also carries some risk, so it’s important to understand what you’re getting into before you start shorting the S&P 500.
You must be an aggressive investor who can tolerate huge risk to lose money when shorting trades. Short sellers must pay a fee to borrow the shares they sell, and those shares are returned to their owners when the contract expires. If the S&P 500 declines and the short seller can’t buy back the contract at a lower price to cover their losses, they must pay the difference.
How to Short the S&P 500 Index in 5 Easy Ways:
1. Buy an Inverse S&P 500 ETF (Exchange Traded Fund)
The simplest way to short the S&P 500 index is by buying shares of an ETF that tracks the opposite performance of the S&P 500. This method is going long (buying shares) and is more straightforward than actually short selling positions.
When you buy shares of an inverse ETF, you are speculating that the underlying index will decline and go bearish. It’s the reverse strategy of investing in ETF that copies the movement of the S&P 500. Now you’re listening so we listed the popular ETFs that follows the opposite results of the S&P 500.
Best Inverse S&P 500 ETFs (Exchange-Traded Funds):
- ProShares Short S&P 500 (SH)
- Direxion Daily S&P 500 Bear ETF (SPDN)
- Xtrackers S&P 500 Inverse Daily Swap
2. Short Sell the S&P 500 with Leverage
Leverage is a way to increase your potential profits when shorting a trade, but it also increases the risk of more losses. Traders who think that the market will continue its bearish trend, they apply some leverage to their short positions, or they buy some inverse leveraged ETFs.
Many brokerage firms offer Exchange-Traded Funds that match the opposite performance of the S&P 500 with X2 or X3 leverage (double or three time the inverse return). You have to be super cautious as leveraged inverse ETFs carry massive risk and can cause sudden losses of money when the market goes out your favor.
Leveraged Inverse S&P 500 ETFs (with X2 and X3 Leverage):
- ProShares UltraShort S&P 500 X2 (SDS)
- ProShares UltraPro Short S&P 500 X3 (SPXU)
- Direxion Daily S&P 500 Bear 3X Shares (SPXS)
3. Buy Shares of Inverse S&P 500 Mutual Funds
Another inverse exposure of the S&P 500 is buying shares of mutual funds that mimic the opposite results of the daily performance of the S&P 500 index. Some mutual funds seek the daily investment negative results, before fees and expenses, of the S&P 500.
Inverse S&P 500 Mutual Funds:
- Bear ProFund
- UltraBear S&P 500 (X2 Leverage)
- Rydex Inverse S&P 500 Strategy Fund Investor Class
- Rydex Inverse S&P 500 2X Strategy Fund (X2 Leverage)
4. Short Trade with Futures Contract
Futures contract can be another technical and complicated terms for newbies. Yet, you must learn about this derivative eventually when you’re trading in the stock market.
A futures contract is a deal to either buy or sell a specific financial asset at a predetermined date and price. In short, it’s like pre-ordering or advance buying or selling. Futures can be traded for almost 24 hours a day, but you cannot hold them forever like shares of stock because they expire.
To short the S&P 500, you can sell S&P 500-based futures like the E-mini or Micro S&P 500 futures. This technique can be more challenging because it carries more leverage and future contracts expire in a designated month.
5. Buying Put Options
Buying a put option is a trading strategy when you speculate that the price of the underlying asset will fall down. A put option awards you a right to sell shares of an asset at the strike price before an expiration date.
For example, you own 100 shares of SPY ETF but you think that the volatile market will cause a bearish trend so you may buy a put option to protect your possible losses.
Final thoughts:
When the market takes a downturn, it can be quite dangerous to short single stocks. Not to mention, determine which stocks to short. While it’s sensible to own an ETF that tracks the S&P 500 index for profit potential and diversification, shorting the index during market crashes can have the same advantages. If you’re looking for extra help, you can always consult a financial advisor or stock market expert.
Disclaimer: This article is for information purposes only and should not be taken as a professional financial advice. Shorting or short selling is quite risky and can cause loss of money. Always do your research and practice due diligence before trading the stock market. Past performance is not an indication of future results.