I saw a post on a board that I frequent that asserted (times being bullish, of course) that since when shorting the risk of loss was infinite and you could only make 100%, it was a stupid thing to do. Since the risk-reward was so poor.

Well shorting stocks is for the birds, I must agree. Too easy to get squeezed out and all you can make is 100%. True enough, and I have long positions which are up 200 and 300% (even after today’s attack on the oils).

But leveraged shorts with Rydex or options? Ah, there is a different kettle of fish.

A Tempest short on the S&P by 600 will be worth 4x the investment - also a 300% gain. (Actually quite a bit more because of compounding on the way down, but how much more depends on the actual trajectory)

And the risk - well let’s say we might move to retest the all-time high around 1500 and you covered there. That would be a 50% loss. Painful, but who would wait that long to cover anyway?

Or options. A SPX June 1150 put now $29 would be worth $550 at SPX 600. That would be a 1800% gain (more or less). If we went to 1500, obviously you would lose 100%. But not such a terrible ratio, I would say.

So what do you think the relative probabilities are? I say 20% 1500, 80% 600. Simplistic, but I’m a simple kind of guy. Obviously a better analysis would have a continuous probability distribution but say I haven’t taken my meds and I’m bipolar today.

So my expected return from the Rydex trade would be (.2*0.5)+(.8*4.0)=3.3 or a 230% gain. The option trade: (.2*0)+(.8*550)=440 or a 1400% expected gain. Whooeee.

So I check my portfolio: Rydex (check) putties (check) I’m good to go. See you in June.

Oh, and by the way the option trade is tax-favored under Sec 1256 and is taxed at 60% long term. So if you want to make a million dollars after tax on this trade, assuming your ordinary income rate is 45% for the sake of argument, then you need to commit the following capital:

Rydex: Pretax gain on one unit is 2.3, after-tax is 2.3*.55=1.265 (short-term gain) so you need to commit $790,000.

Options: Effective tax rate is (.6*.15)+(.4*.45)=.27 and pretax gain on one unit is 14, after tax is 10.22, so you need to commit $98,000.

Too bad I can’t use options in my IRA.