Short selling bonds requires careful analysis of market conditions, timing, and interest rates. Shorting bonds is a negative bet against the asset’s value, and bonds likely to fall in price and rise in interest rates are good candidates. Shorting ETFs based on bonds is an alternative approach. Interest rates are crucial, and shorting long-dated or high-yield bonds can be expensive. Sovereign debt is a good candidate for short selling. Bond ratings are usually priced into the market.
Short selling bonds requires a very careful analysis of prevailing market conditions in order to correctly identify bonds that may be underperforming, and it requires careful timing in order to derive the greatest benefit from this identification. A short position in bonds also requires careful attention to the interest rates applied to the bonds in question. The right financial instruments should also be selected to facilitate short selling of bonds. In some cases, this will involve the actual short selling of bonds, while in others it will involve the short selling of bond-based exchange-traded funds, or ETFs.
As with any short sale, shorting bonds is essentially a negative bet, a bet against the value of an asset. Any bond whose price is likely to fall and on which the interest rate will rise is a good candidate for short selling. Sometimes a careful market analysis can reveal companies or nations whose debt will soon be under pressure or who will soon face further debt hurdles. Sovereign debt is often a good candidate for short selling because these securities are widely held and usually actively traded, and because information about economic conditions affecting nations as a whole is widely available. Bond ratings can sometimes be a useful indicator of bond quality, but this information is usually already priced into the market.
Interest rates are a crucial factor to consider when thinking about shorting bonds. When shorting shares, an investor is only responsible for any increase or decrease in the price of the shares he borrowed to make it go short. When downgrading a bond, however, an investor must plan to cover the ongoing interest produced by the bond and pay that interest to the original owner of the bond. The role of interest in the short selling of bonds tends to favor short selling of bonds whose values are likely to collapse sooner rather than later. Short selling long-dated bonds can be very expensive propositions, as can shorting high-yield bonds.
A useful alternative approach to direct shorting of bonds is to short ETF shares based on bonds. Because ETFs can be bought and sold like stocks, shorting these securities is an easy way for investors to effectively short bonds without having to enter into the somewhat more complicated deals required to directly short bonds. This method of shorting bonds allows for a good but not always perfect investment objective. The sovereign debt of most nations can be accessed by trading ETFs, but the debt of individual companies or states isn’t always accessible, and investors following this approach may need to short an entire debt category.
Smart Asset.
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