How to Play the Bond Market Crash

A little over a week ago, I recommended shorting the iShares PLC Markit iBoxx Euro High Yield Bond ETF (LON: IHYG).

Several readers wrote in to say that “not every brokerage lets you buy this.” Some do, in fact: In this day and age, many brokerages let you buy any shares, anywhere. But for those of you whose brokerages won’t let you, I want to give you an alternative.

[ad#Google Adsense 336×280-IA]We want a trade that gives us the exposure we want, which is a bet on falling bond prices – both sovereign and corporate – across Europe.

It’s hard to find an exchange-traded fund (ETF) that gives us this type of exposure.

Some of the instruments that come close don’t have the liquidity we need to be able to get in and out easily.

And the rest don’t fit the trade profile we want.

However, there’s another way to play falling bond prices across Europe…

Averaging Up

If bond prices fall, banks and financial institutions holding them will take a tumble, too.

So, if you want exposure to falling European bond prices, I recommend shorting the iShares Trust iShares MSCI Europe Financials ETF (Nasdaq: EUFN).

My recommendation would be to short EUFN here at $23.25 or higher. Personally, I have a high tolerance for risk (that’s because I have the capital to risk), so I would short an equal additional amount at $24.50, more at $25.50 and more at $26.50, which is the ETF’s 52-week high.

If you “average up” on this short, you’d be short at an average price of $25. I’d cover my shares at $27.50 if the ETF makes a new high there. I’d accept a 10% loss – with a frown, for sure. But a 10% loss is acceptable to me.

Another way to play a drop in this ETF would be to buy these…

The October $21 Puts options. I’d pay 50 cents apiece for them. However, because timing is a lot tougher with options – and because if the puts expire worthless you’ll lose everything you invest in this trade – I’d risk a lot less than what I’d be willing to put down to short the stock.

Of course, if EUFN drops like a stone and ends up below $20 by expiration, the put options will have a much higher return.

You also don’t have to wait until expiration to sell your puts. If you want to cut your loss in the case the trade goes against you, you can sell them at any time. And you can sell them before expiration to potentially make a killing if EUFN drops a lot before expiration.

Have at it – and good luck to us!

— Shah Gilani

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Source: Money Morning