Bears might be convinced that the sharemarket is going to fall, but that doesn’t mean that being ‘bearish’ equates to being grumpy.

Buying a security that will rise in value if the stock market falls means that you’re not only having your opinion vindicated, you’re making money.

One of the simplest ways to be a bear is a relatively new product, the BetaShares Australian Equities Bear Hedge Fund (ASX code: BEAR), which is designed to give investors a simple way to profit from, or protect against, a decline in the Australian share market.

Launched in July 2012, BEAR is a listed hedge fund that is able to generate returns that are negatively correlated to the returns of the Australian share market (as measured by the S&P/ASX 200 index). Generally speaking, a fall in the S&P/ASX 200 Index will cause the value of the BEAR Fund to rise. Conversely, a rise in the S&P/ASX 200 Index will see the BEAR Fund fall in value.

The BEAR Fund can be bought or sold throughout the trading day on the ASX, and trades like ordinary shares. The fund is managed for 1.19 per cent a year.

The Bear Fund invests in cash and cash equivalents (BetaShares’ high-interest cash exchange-traded fund (ETF), which gives a yield 95-basis-points higher than the standard RBA rate), and sells futures contracts over the ASX SPI 200, which is the futures market alter ego of the S&P/ASX 200 index. Being ‘short’ the index generates a positive return when the S&P/ASX 200 index declines – but the flipside of that is a negative return when the S&P/ASX 200 Index rises.

The BEAR Fund is managed actively to ensure that on any given day its net exposure varies between 90 per cent short and 110 per cent short. This means that a 1 per cent fall in the S&P/ASX 200 index on a given day can be expected to lift the value of the BEAR Fund by between 0.9 per cent and 1.1 per cent.

There is no leverage, no possibility of a margin call and downside risk is limited to the amount invested.

“We think this is the simplest way to go ‘short’ on the Australian stock market,” says Drew Corbett, chief executive officer of BetaShares. “It is very straightforward, it is simply an unleveraged short position on the sharemarket.

“But somebody holding the BEAR Fund shouldn’t be thinking that it is a perfect one-for-one short position, because it fluctuates between 90 per cent short and 110 per cent short. That’s the beauty of it, that the fund will rebalance automatically, based on those rules: the ‘short’ is managed within the fund so the investor doesn’t have to,” says Corbett. “But that means that it won’t provide the exact opposite return.”

The BEAR Fund can be – and is – used for both hedging and speculation, says Corbett. “For people who are more trading-oriented, and want a straight ‘short’ for a short-term speculative view of the market in the coming days, it is very useful. But we also see financial planners using the fund, positioning it as a 5 per cent holding in certain client portfolios, as a portfolio hedge. They generally do it on a three-month view with monthly or even weekly monitoring.”

Generally a short position is not designed to be a set-and-forget strategy, says Corbett. “It can be traded intra-day, most people would hold it for a matter of days. Bear market periods have lasted as long as six months or a year, so some people might want to hold the BEAR fund on an ongoing basis. But if you want to hold a short position on an ongoing basis, you’ve got to monitor it constantly.”

Traders and investors can also use contracts for difference (CFDs) over the sharemarket index. Index CFDs represent a theoretical order to buy or sell the index, the investor simply closes the transaction by taking the opposite action, and the investor’s final profit or loss is determined by the difference between the opening and closing price, with the difference paid at the close of the contract.

Index CFDs are commission-free, and you can trade for $1 a point. Index CFDs generally trade around the clock during the week, although they shut down over the weekend. The CFD providers will mostly offer a continuous price as many of them base their price feeds on the futures products that mirror these indices. About 25 indices are offered, including US sectoral and capitalisation-specific indices. Index CFDs are also listed on the ASX.

For speculators, a very pure short-term directional trading instrument is CFD provider IG Markets’ Binary CFD, which quotes a price on the probability of the Australia 200 index finishing higher or lower at the end of the trading day. (Like all index CFDs, the binaries cannot use the actual trademarked indices, which are usually trademarked, for example the S&P/ASX 200.)

Binaries are also offered on the Wall Street index (based on the Dow Jones), the US SPX 500 (based on the S&P 500), the France 40, the Germany 30, the FTSE 100 and the Singapore Blue Chip. Binaries are also quoted on weekly and hourly positions, as well as 20-minute and five-minute contracts on the FTSE 100 and Wall Street.

Whereas index CFDs are priced according to IG’s quote on an index level, the binary price is just the probability of directional movement. For the Australia 200 index, based on the overnight lead from the US markets, IG quotes a price – between zero and 100 – on the index rising on the day, by any amount. If the index closes higher, the trade settles at 100: if it closes lower, the binary settles at zero. Traders can close out the trade at any time.  

“Binaries are not one of our most traded products, but we find that when people get into it, they like to stay with it. For someone who thinks they have a good feel for the markets in the short term, and who thinks they can see value where our binary is mispriced, can do quite well on it,” says Weston.

Someone expecting the Australian sharemarket to fall could also use index MINI warrants, traded on the ASX, which give the notional right to ‘buy’ or ‘sell’ the S&P/ASX 200 Index. If you think the market is poised to fall, you can buy a ‘put’ warrant or sell a ‘call’ warrant.

MINIs have no fixed expiry date and are open-ended. Because MINIs are leveraged investments, you have to watch the downside, although index MINIs offer a free stop-loss level: this ensures that the value of the index MINI can never be negative. In a worst-case scenario, you can never lose more than your initial capital outlay. In contrast, when you trade CFDs, you are responsible for setting your own stop-losses.

Another means of trading a view on the market’s direction is the Sydney Futures Exchange (SFE) Share Price Index Intra-Day Options (SPIDO), launched in 2004 specifically to give investors the ability to trade their view on whether the sharemarket will rise or fall on any given day. The SPIDO is a cash-settled options contract based on the SFE SPI 200 futures contract (which is itself based on the S&P/ASX 200 Index), with a life cycle of one day.

Each morning, depending on how the US indices performed overnight, the SFE quotes an at-the-money (ATM) strike price for the SPIDO, as well as six strike prices – each five points apart – below the ATM strike, and six strike prices – also five points apart – above the ATM price.

A person convinced that the Australian market is set to fall that day could either buy a SPIDO put or sell a SPIDO call. In both cases, strikes higher than the ATM are in-the-money.

Each new day means a completely new SPIDO. The SPIDO opens for trading at 9:50 am each morning and closes at 4:20 pm that afternoon. As the underlying share price index moves, new strikes are continually quoted, and the SPIDO can be bought and sold at any time during the trading day. The profit or loss on the SPIDO at expiry is simply the difference between the strike price and the settlement price. With the SPIDO, your downside risk is limited to 100 per cent – that is, to your original investment.

Weston says many traders use moving averages in bear strategies. “If you get a five, ten and 20-day moving average, and when you see on the chart all three of them heading south, in that order, you’ve got what I would consider a downtrend.

“If you follow that average until the five-day crosses back up across the ten-day, that’s your exit signal. You probably won’t pick the top or pick the bottom, but you can get the bulk of the fall. As soon as those three align again, you re-open the short,” he says.

All of these speculative methods – with the exception of binary CFDs, which are more trading-oriented – can also used to hedge a share position. If the market experiences a sudden pullback, rather than selling or reducing their share holdings, holding a short position on the index should give a rise in value that lessens some of the pain of the market fall.

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