How to Play the Bond Market Crash

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Readers: This article is a follow-up to Shah's original recommendation on how to make a killing with the imminent 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.

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 UpStock Market Crash

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 put 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!

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About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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