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Monday March 17, 12:09 PM
Seven ways to make money in falling marketsBy dollarDEX.com
Sign up for the seminar: Gold, silver, platinum? The case for precious metals, Thursday, 27 Mar 2008, 1830-2000. An earlier version of this article first appeared in the dollarDEX Investment Bulletin for 14 August, 2007. Although we believe it's probably best during market jitters to maintain a balanced portfolio and augment that by adding to equities (assuming valuations are sensible), we describe here seven ways to potentially make money in falling stock markets. Importantly, clients should not rush into these - a strategy dependent on falling markets will be a money loser if employed at the bottom of a market correction. Moreover, the last three strategies below can be very risky in the hands of a novice. 1. Switch to cashThe easiest approach of all is to earn a safe return in a cash fund. For example, Lion Capital SGD Money Market Fund aims to manage liquidity and risk while looking to provide a return which is comparable to that of SGD short-term deposits. The fund will invest in high quality short-term money market instruments and debt securities. Some of the investments may include government and corporate bonds, commercial bills and deposits with financial institutions. In the last 12 months (to 21-Jan-2008) the fund has returned over 2.5% with hardly any volatility.2. Switch to gold/commoditiesGold, other precious metals, oil and soft commdities (such as wheat futures) can be safe havens or even highly profitable in times of crisis. Retail investors could consider DWS Noor Precious Metals Securities Fund and accredited investors have the option to target soft commodities in the Castletone Aliquot Agriculture Fund.3. Switch to currenciesCurrencies also offer a way to buck the stock market trend. So a fund like DWS Currency Fund could be very useful, as its correlation with stocks is relatively low.4. Switch to an absolute return fundHedge funds aim for absolute returns - that is, they aim to deliver positive returns to investors regardless of whether markets are rising or falling. Contrast this to conventional unit trusts, which usually aim to outperform a benchmark; in other words, they aim to return higher than the market in bull markets, while in bear markets, they aim to fall by a lesser degree. Furthermore, in trying to achieve its objective, hedge funds have the flexibility and ability to take on a wide variety of styles and strategies, such as the use of short-selling and leverage. This is different from conventional unit trusts, which are usually restricted to long-only positions, that is, to buy a security with the prospect of selling it at a higher price later. An example, of such a fund is Platinum All Star.5. Buy short ETFsExchange Traded Funds are bought like shares but track a market index and are similar to index mutual funds. Recently some ETFs have been introduced that short various indexes. This means the ETF goes up in value when the index goes down (and vice versa). For example, ProShares Short Nasdaq QQQ ETF (symbol PSQ) rises in value as the NASDAQ index drops, and falls when the same index rises. Hence, a 5% index drop would cause PSQ to rise about the same amount. The ProShares Ultra series doubles the movements. Buy shares of Ultra Nasdaq QQQ ProShares ETF (Symbol: QID), and they will go up twice the rate of the decline in the underlying index. If the index drops 5%, an investment gains 10%. Likewise, it will go down at double the rate if the index goes up. ProShares has a collection of ultrashort ETFs worth examining, including
6. Buy PutsA Put option (sometimes simply called a "Put") is a financial contract between two parties, the buyer and the writer (seller) of the option. The Put allows the buyer the right but not the obligation to sell a share to the writer of the option at a certain time for a certain price (the strike price). The writer has the obligation to purchase the underlying asset at that strike price, if the buyer exercises the option. The buyer pays a fee (called a premium) for this right. The Put buyer either believes it's likely the price of the underlying asset will fall by the exercise date, or hopes to protect a long position in the asset. The advantage of buying a put over shorting the asset is that the risk is limited to the premium. The subprime crisis has caused a loss of confidence in banks, causing their share prices to fall. So a Put on a bank share could make money as the share price drops further. An example is the Put "C Aug 47.5" (symbol OPRA: +CTW) which is a Put on the shares of Citigroup (symbol C). Depending on the price paid for it, an investor will make money if Citigroup's share price falls further. There are at least two other ways of using puts in a downward market: Bear Put Spread: A bear put spread is a debit spread created by purchasing a higher strike put and selling a lower strike put with the same expiration dates. This strategy is best implemented in a moderately bearish market. It provides high leverage over a limited range of stock prices Covered Puts: In a covered put strategy, you are selling the underlying stock and selling a put option against it. This strategy is best implemented in a bearish to neutral market where a slow fall in the market price of the underlying stock is anticipated.7. Buy Calls on VIXA Call option is similar in structure to a Put except the buyer of a Call wants the price of the underlying instrument to rise in the future. The buyer of a Call has the right, but not the obligation to buy an agreed quantity of a share from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right. An investor wanting to bet on rising fear (or market volatility) can make money using a Call on the VIX index. An example is the Call "VIX Aug 30" (symbol OPRA: +VIXHF) which is a Call on the VIX index. Depending on the price paid for it, an investor will make money if VIX rises from the point the Call was purchased.Stop lossIt's also worth mentioning that some funds have built-in stop loss features. For example, Castlestone Protective Equity Emerging Markets maintains a 8.00% stop-loss to limit the risk of capital loss. While this strategy may not generate positive returns during falling markets, they have the potential to limit downside movements.
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