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Should I short the S&P 500?

Published by: Lucien Paulemil
June 18, 2022 1:42 pm

Gary Shilling's interview might have got you thinking, "Should I short S&P 500?" Well, that curiosity might have led you here. But before we jump right to the main part, let us discuss a few basics.

What is S&P 500?

S&P 500, also known as the Standard and Poor 500, is an index of 500 U.S. companies that are listed on the U.S. stock market and prioritize market capitalization. 

But what's all the buzz regarding S&P 500 about? Well, this index tracks these publicly traded domestic companies and gives them a percentage allocation based on their market capitalization. The market capitalization, in turn, is adjusted by the number of shares of the company available for public trading. Since the criteria are having a leading market capitalization and total outstanding shares worth 10 billion dollars, you might find several companies on the list that you'll be hearing about for the first time.

Due to several reasons, S&P 500 is recognized on a global level as one of the best benchmarks for the performance of the U.S. stock market. To give you an insight, the S&P 500 represents about 83 percent of the entire domestic U.S. equity market capitalization. The index's diversity and depth are a few reasons why experts consider it one of the best gauges of large stocks. 

The only major flaw of the S&P 500 is highlighted when stocks become overvalued. As a result, the stock inflates the overall price of the index.

What is shorting a stock?

If you're not an investment and stock exchange expert, "shorting a stock" might be a new term for you. You might be used to the conventional methods and modes of investment by buying a stock when it is in decline and selling it after a profit.

Well, shorting, also known as short-selling, is the complete opposite. If you want to short a stock, you borrow a share that you don't own and sell it to another investor. 

You'll understand better with this example. You buy 10 shares of XYZ Company's stock from a brokerage at a share price of 100 dollars and sell all the shares for a thousand dollars. After a few days, the share price drops to 80 dollars. So you buy back all the 10 shares for 800 dollars and return them to your broker, and keep a profit of 200 dollars.

In this example, it is clear that for shorting to be successful, the investment has to drop instead of seeing a rise. Additionally, short-selling works best if you have a short-term profit strategy. It is not ideal for a long-term plan since most stocks have a clear upward bias in longer time spans. That said, short-selling is no doubt a risky play and can cost you a small fortune, which is why it is not every investor's game.

Should you short S&P 500?

Now that we are familiar with both shorting and S&P 500, we can address the elephant in the room. Should you short S&P 500? Will it bring you profit? Or will you see your investment go down the drain?

We talked about shorting and when and how it is profitable. Well, you could, and probably should, short S&P 500 if you fulfill these 3 conditions:

  1. Know the market: 

As a whole, the stock market has seen a marked and dramatic jump, especially after the containment of the coronavirus. According to experts, the indexes have returned to pre-covid levels due to the virus's containment and recovery. On the other hand, inflation is skyrocketing across the country, along with more cases of unemployment, with an imminent risk of recession. Due to these reasons, several analysts and experts are in favor of shorting stocks and encouraging people to go for bear funds. But, S&P 500 is a big term and includes a long list of companies. To make it easier for us, analysts and financial experts have divided the 500 companies into different sectors. Some individual sectors have trends of their own, which is why you have to decide whether now is a good time to short them or not based on their predictions.

  • Information technology: The IT sector, as a whole, has taken a big hit for a couple of months. Business tycoons like Apple and Amazon have suffered a dent in their stock prices, which could even sink. So there is potential to gain profit by shorting the stocks of IT companies.
  • Consumer staples: Consumer staples companies are all in the green. While IT companies are having bad days, these companies are living in a dreamland. So it is definitely not worth shorting the stock of companies like Campbell Soups, J.M. Smucker, and General Mills.
  1. Make a guess: 

We discussed this in our example that the only way you go home with a profit is if the stock you bought is about to decline. Instead of the price dropping to 80 dollars, imagine it spikes to 200 dollars. Now, while you re-buy the stock from the person you sold it to and return it to your broker, you will have to pay him an extra thousand dollars from your pocket. So, you should only short S&P 500 when you know that the companies are about to experience a loss.

  1. Are a short-term investor: 

Short-selling is for short-term investors. You can not short the S&P 500 companies if you're thinking of investing for a long period. Although most of the share prices of these companies fluctuate dramatically, their value steadies out and eventually rises after a while.

  1. Are a risk-taker: 

Well, this is the biggest ask. You can not expect to make money by short-selling any company, let alone the S&P 500, without a risky investment. 

For starters, you can not be sure that the share price will fall unless you have insider information, in which case you are committing a felony. Your, or anyone else's, for that matter, guesses or predictions can go wrong.

You might be thinking that with the market facing a recession, you are good to go. But there is always a risk. 

A good way to short a company is by buying numerous shares from your broker and then selling most, if not all, of them to other investors. Doing so will reduce the price, and you'll go home with a profit. But this can only be done with shares of a small company. So, you will have to take a big risk if you want to short the S&P 500.

How to short S&P 500:

If you have made your decision and are thinking of shorting the S&P 500, you can make sure your increase your chances of making a profit by opting for these 4 strategies:

  1. Make use of the inverse S&P 500 Exchange Traded Funds (ETFs). The S&P 500 ETF closely tracks the S&P 500 benchmarks and is huge and liquid.
  2. Go for the inverse S&P 500 mutual funds, also known as bear funds. The ProFunds and Rydex mutual funds have a reputable and successful history. 
  3. Buy a put option on the ETF. You can even buy a put directly on the S&P 500 index, but it has its risks, the biggest of all, which is liquidity.
  4. Try an index future contract. If you go for the S&P 500 futures contract, you are bound to get huge leverage.

Take-home message:

S&P 500 is an index that lists 500 U.S. companies based on their market capitalization. You can short any of these companies, but you'll have to plan a short-term investment, predict that the share price will decrease, and take a risk. There are several ways to help you short S&P 500.

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