Bear securities

3 key takeaways

• Bear securities profit when the price of the underlying asset decreases.
• Common types of bear securities include inverse ETFs, put options, and short-selling.
• These instruments can be used for hedging or speculative purposes.

What are bear securities?

Bear securities are financial products that gain value when the price of the underlying asset falls. They are used by investors to profit from declining markets or to hedge against potential losses in their portfolios. Bear securities can take various forms, including inverse exchange-traded funds (ETFs), put options, and short-selling strategies.

Types of bear securities

1. Inverse ETFs: These are designed to move in the opposite direction of the underlying index or asset. If the index decreases in value, the inverse ETF increases in value.
2. Put options: These give the holder the right, but not the obligation, to sell an asset at a predetermined price within a specified time frame. The value of a put option increases as the price of the underlying asset falls.
3. Short-selling: This involves borrowing shares of a stock and selling them with the expectation that the price will decline. The investor can then buy back the shares at a lower price, return them to the lender, and pocket the difference.

How do bear securities work?

1. Inverse ETFs: These ETFs use derivatives to achieve the inverse performance of the underlying index. For example, if an inverse ETF tracks the S&P 500, it aims to increase in value when the S&P 500 decreases.
2. Put options: Investors purchase put options to gain the right to sell an asset at a specific price (strike price). If the asset’s price falls below the strike price, the investor can sell at the higher strike price, making a profit.
3. Short-selling: Investors borrow shares and sell them at the current market price. If the price drops, they buy back the shares at the lower price, return them to the lender, and profit from the difference.

Examples of bear securities usage

1. Inverse ETFs

• ProShares Short S&P 500 (SH): This ETF seeks to provide the inverse (-1x) of the daily performance of the S&P 500. If the S&P 500 declines by 1% in a day, the SH ETF aims to increase by 1%.

2. Put options

• Buying puts: An investor buys a put option on a stock currently trading at $50 with a strike price of $45. If the stock price falls to $40, the put option gains value, as the investor can sell the stock at $45, higher than the current market price.

3. Short-selling

• Shorting a stock: An investor believes that Company XYZ, currently trading at $100 per share, will decline in value. They borrow 100 shares and sell them for $10,000. If the price drops to $80, the investor buys back the shares for $8,000, returns them to the lender, and keeps the $2,000 difference.

Importance of bear securities

• Hedging: Bear securities allow investors to protect their portfolios against potential losses by profiting from declining prices.
• Speculation: These instruments provide opportunities for investors to speculate on market declines and potentially earn significant returns.
• Market balance: Bear securities contribute to market liquidity and price discovery by allowing investors to express bearish views.

Real-world application

Example: An investor is concerned about a potential market downturn due to economic uncertainty.

Inverse ETF: The investor purchases shares of the ProShares Short S&P 500 (SH). As the S&P 500 declines, the value of the SH ETF increases, offsetting some of the losses in the investor’s other holdings.

Put options: The investor buys put options on a tech stock that they believe is overvalued. If the stock price falls, the put options increase in value, allowing the investor to sell the stock at a higher strike price and profit from the decline.

Short-selling: The investor identifies a company with weak financials and short-sells its stock, expecting the price to drop. When the price declines, the investor buys back the shares at a lower price, returning them to the lender and keeping the profit.