On its face, the Dow Jones’ 4.4% drop in August does not look particularly bad. After all, a typical correction is 10%. Yet the month was harrowing, as the volatility spiked. Keep in mind that the average daily move was nearly 2%.
While such swings are great for savvy traders, it can be extremely tough for longer-term investors. In fact, even the pros had difficulties in August. For example, hedge fund managers like Steven Cohen and David Einhorn posted losses. However, John Paulson was the most notable loser as his flagship fund plunged 35%. He had heavy exposure to stocks like Bank of America (NYSE:BAC) and Citigroup (NYSE:C).
Yet there were some investors who were able to find ways to make money, such as Carl Icahn, Kenneth Griffin and Ray Dalio. They were savvy with safe havens like the SPDR Gold Trust (NYSE:GLD), as well as currency plays.
But there is something else that worked: short selling. For example, Icahn scored $100 million by shorting the S&P 500.
True, short selling can be risky. This is especially the case when going after high-fliers like Chipotle Mexican Grill (NYSE:CMG) and Lululemon Athletica (NASDAQ:LULU).
But when done as a part of diversified portfolio, short selling actually can help to reduce risk. Essentially, you are setting up a hedge.
Interestingly enough, the short interest in the S&P 500 has reached the highest levels in about nine months — coming to 3.03% of the overall market value, according to a recent report from Bloomberg.
No doubt, there are many reasons to be bearish. The global economy is slowing down, and the U.S. and Europe have sovereign debt problems. If anything, the surge in gold prices is a stark reminder that investors are skittish.
So, should you short the S&P? It’s incredibly difficult to time the markets. But so long as the volatility continues, it probably is a good idea to have some short exposure.
As I’ve mentioned in a recent piece for InvestorPlace.com, there are some good options to look at, such as the ProShares Short S&P 500 (NYSE:SH) and the Federated Prudent Bear Fund (MUTF:BEARX). And even PIMCO’s Bill Gross has a short-oriented fund, which is called the StocksPLUS TR Short Strategy Fund (MUTF:PSSAX).
Tom Taulli is the author of various books, including “All About Commodities.” He does not own a position in any of the stocks named here.
