Because bonds, like any other security, experience market fluctuations, traders may be eager to profit from a bet that the price of a bond will go lower. You can sell a bond short, but it can be trickier than shorting stocks.
- It is possible to sell short bonds by borrowing them and selling them in the market, hoping to buy them back lower.
- But there are certain issues such as making required interest payments that makes shorting bonds more complicated than shorting stocks.
- Other ways of betting against the bond market is through inverse ETFs.
Short selling is a way to profit from a declining security (such as a stock or a bond) by selling it without owning it. Investors expecting a bear market will often enter a short position by selling a borrowed security at the current market price in the hope of buying it back at a lower price (at which time he or she would return it to the original owner).
Short sellers in the stock market are usually concerned with their expectations of a company's future earnings (the main factor determining stock price), whereas short sellers of bonds are most concerned with future bond yields, the determining factor of bond prices. Anticipating bond prices requires careful attention to interest rate fluctuations. Essentially, as interest rates jump, bond prices tend to fall (and vice versa). Therefore, a person anticipating interest rate hikes might look to make a short sale. (To learn more about the factors that affect bond prices, read the Bond Basics tutorial.)
Selling short can be a great strategy for making money in a market that is sluggish or declining. However, exercise caution before you jump into short selling bonds—or any other security, for that matter.
Here's What the Experts Have to Say:
Rick Konrad, CFP®, CFA
The Roosevelt Investment Group, Inc., New York, NY
It certainly is possible to sell a bond short, as you would sell a stock short. Since you are selling a bond that you do not own, it must be borrowed. This requires a margin account and, of course, some capital as collateral against the sales proceeds. There are interest charges for borrowing too. Just as an investor who shorts a stock must pay the lender any dividends, a short seller of a bond must pay the lender the coupons (interest) owed on the bond.
Consider using an inverse bond ETF, designed to perform the opposite of its underlying index. These vehicles allow you to short bonds on the basis of maturity or by credit quality. But their expense ratios tend to be higher than their "long" counterparts, as they require greater effort and monitoring on the part of the ETF sponsor.