Which Bank to Short Sell Now!

If your editor was a trader, the big trade we’d take a swing at now would be to bet against the banks again.

But make no mistake, when we mention the word ‘bet’ we mean it. We’re not talking about rigorous fundamental analysis that we do for Australian Small-Cap Investigator or Australian Wealth Gameplan. And neither are we talking about the type of technical analysis our Slipstream Trader Murray Dawes uses.

We’re talking the kind of bet that you’d make at the TAB. The kind of bet where you take a quick glance at the form guide and then shove a few bucks on it.

Of course, there’s a big difference with this kind of bet when compared to throwing a few bucks at the nags or the dish-lickers.

That’s because typically you’ll find it hard to just place a $10 bet against the banks. And even if you could you’d find your reward pretty thin.

Back in mid-January we suggested it might be an idea to think about short-selling Commonwealth Bank of Australia [ASX: CBA] shares. We didn’t quite have the kahoonas to actually tell you to do it, which was a shame because after a brief rally it sank to around $51 a share from a peak of $57.

Today CBA is back above $57:

And still we can’t think of any reason why investors would want to own bank shares. Look, we won’t go into all the reasons again – overleveraged to the housing market, $2.20 of reserves for every $100 deposited, etc…

We’ve covered all that before.

But to our way of thinking, if you like a punt and you’re not afraid of taking on a bit of risk, why wouldn’t you bet on CBA moving to the downside from here?

As I’ve mentioned, it’s a punt, and betting against the banks means betting against the entire investing mainstream establishment. But quite frankly I think it’s something worth considering. Just make sure you’re fully on top of the risks should the bank shares continue to rise – which is entirely possible.

In a moment I’ll give you some pointers of two ways to play it if you do fancy taking a punt against the banks. But before I do that, let me get some disclosure stuff out of the way first…

For starters, your editor doesn’t own any bank shares.

Second, your editor is not front running this trade. In other words we haven’t taken a position to short sell the banks prior to writing this article. And furthermore, neither have we instructed any of our associates, friends, relations, friends of relations, relations of friends, friends of associates… [Reader's voice: Enough already, we get the picture!] to enter into this trade either.

And nor will we ‘back run’ the trade by jumping on the bandwagon afterwards, riding on the coattails of potential profits.

Hopefully that makes it clear for you. As an aside, we take exactly the same approach with our tips in Australian Small-Cap Investigator and Australian Wealth Gameplan. We don’t make any personal investments in those tips either.

Our personal view – and that of Port Phillip Publishing – is that even the appearance of a conflict of interest is bad for business.

Our business is doing the research, offering advice, providing ideas you won’t read anywhere else and leaving you to potentially make profits on the tips. Simply put, we enjoy writing about stocks, the market and the economy.

We leave it up to you to put your investing dollars on the line. If you profit you’ll probably subscribe again. If you don’t, then maybe you won’t subscribe again. It’s as simple as that.

Anyway, back to our bet against the banks.

When it comes to taking a punt on falling stocks I prefer to use low-risk methods which I’ll go through in a moment. You could of course just go to your broker and ask them to short sell physical stock.

The only problem with that is the broker will typically require a minimum trade of $50,000. For most people, that’s too big of a punt. Secondly, your risk management choices are fairly limited. Not all brokers offer stop loss facilities, and even if they do, it isn’t always a foolproof way of cutting losses.

That’s why I prefer to highlight the following two methods.

The first is to use something called Contracts for Difference (CFDs). I’ll be straight up, these are highly leveraged financial products. How leveraged? Put it this way, with some CFD providers you can put down $100 and get exposure of up to $10,000!

That’s 100-to-1 leverage, and it could be the quickest way to the poorhouse if you mess it up. You’d have to be mental to use that kind of leverage without considering the risks.

And if you think we’re being hypocritical talking about massive leverage in the stock market while lambasting excessive leverage in the housing market, then we’ll cop that.

But we will make one point to argue the case. We’ve never argued that the stock market is all blue sky and no downside risk. In contrast, our property spruiking pals only ever talk about the upside and never address the downside.

As an example, have you ever read a property spruiker saying you could head to the poorhouse if you mess up the investment?

Anyway, we’ll leave that one with you to make up your own mind.

Besides, with CFDs, just because the leverage is available it doesn’t mean you have to use it. For instance, if you normally trade $5,000 lots and you have $5,000 available, you can deposit the cash in your CFD account and enter a short sell for 87 CBA shares.

That gives you around a $5,000 exposure. If the price of CBA falls then you’ll move into profit. If the price of CBA rises then you’ll make a loss.

But here’s where you can limit your losses. It’s called a Guaranteed Stop Loss. I won’t go into all the details here, get in touch with the guys at City Index or CMC Markets and they’ll give you the full rundown.

In a nutshell, for a small fee the CFD provider will allow you to set a level at which you’re guaranteed not to lose any more money than a preset amount. So, as an example you could set your guaranteed stop loss at a CBA share price of $60. If CBA trades higher than that then you’ll lose no more than around $3 per share – about $260 if you short sell 87 shares.

Short selling can be pretty risky. That’s why I’d recommend you prepare to arm yourself with the proper risk management tools such as guaranteed stop losses.

Of course the flipside is, if CBA did drop to around $51 as it did recently then you’d lock in over $500 of gains. Not a bad return by anyone’s standards.

But look, remember this isn’t personal advice. If you like the sound of what I’ve mentioned just make sure you check out all the risks with the CFD provider. And also remember that by short selling the banks you’re betting against the entire mainstream investing establishment. Talk about swimming against the tide!

The other way to potentially gain from falling share prices is to look at exchange traded options. Or just ‘options’ as they’re more commonly called.

Again, there’s a whole bunch of risks involved, so make sure you check out all the details before going ahead with anything. In fact, your broker will make you complete a risk profile document to make sure you fully understand what you’re getting involved with before they’ll accept your money.

In this instance, a handy little punt is to look at May 2010 expiry put options on CBA. Right now you can take out a put option with a strike price of $55 for just 53 cents per share.

With a contract size of 1,000 shares, you’d be looking at a total cost of $530 for just one contract. Generally speaking – we won’t go into the complex stuff here – you’d need the CBA share price to fall below $54.47 in order to return a profit.

Anything below that and you’re in the money. The important point to remember with options is that they expire. So if the CBA share price didn’t move between now and the end of May then you’d lose your entire $530.

But as I say, get in touch with your broker to find out more info.

Look, we only ever look at basic options strategies in Australian Wealth Gameplan. And for the most part we’re only interested in low risk strategies. For instance just last month we recommended subscribers consider taking out covered call options against three of the stocks in the portfolio.

In that strategy we still like the stocks, but with the market near a short term high we figured it was a good time to earn some extra income in the event that stock prices didn’t move higher.

Anyway, I thought I’d give you something a little different in today’s Money Morning. Take it with a pinch of salt if you like. You know how much we dislike the banks, and we figure this is the best way to potentially profit if they do take another turn for the worse.

We’ll keep an eye on the CBA share price and let you know whether this would have been a winning or losing trade!

Cheers,
Kris.

Tagged as: australian small cap investigator, Australian Wealth Gameplan, bank, broker, cba, Contracts for Difference, short sell, slipstream trader, trade