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One easy way to profit from an S&P/ASX 200 market crash

If you think the market will fall, there are two seemingly unusual exchange traded funds (ETFs) that you can buy and make a profit if it does fall.

The BETA BEAR ETF UNITS (ASX: BEAR), as it is found on Google Finance, and the BetaShares Australian Equities Strong Bear Hedge Fund (ASX: BBOZ) enable you to make a profit when the market falls.

Like a growing majority of ETFs, they do not passively track an index such as the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO). The ETFs use a set of rules to construct a fund which you can buy into on the market, like any other ordinary share.

How does it work?

The ‘BEAR’ fund uses its pool of capital, which accumulates when investors buy units in the ETF (similar to buying an ordinary share in a company) to sell ASX 200 futures contracts. If that all sounds a little confusing, don’t worry, I’ll explain.

A futures contract is a just contract which obligates you to do something in, yep, you guessed it, the future. By selling a futures contract on the ASX 200 the ETF is obligating itself to make payments to another party if the index rises.

For example, if the BEAR ETF sold a futures contract at today’s ASX 200 price of approximately 5,500 and the index went up to 5,600, they would pay the 100 points difference to the other party. That is about 1.8% (i.e. 100 / 5,500 = 1.8%) of the amount of the contract sold.

If the price went down to say 5,000 points, the BEAR ETF would receive a payment from the other party. In this example, it would be around 9% (i.e. 500 / 5,500 = 9%). Sounds simple enough. 

The ‘Strong Bear’ ETF does exactly what the ordinary BEAR ETF does, but it doubles the exposure. Meaning, index changes have twice the effect.

Like virtually all other ETFs these funds charge management fees.

Why do people use these things?

Investors choose to use these types of ETFs as a way to protect against losses or bet on a market crash. The ETFs provide an alternative to other devices like contracts for difference (CFDs), shorting a stock (which is usually only available to professional fund managers), options, and individual futures contracts.

BEAR and Strong Bear are just two examples of the many different types of strategies which can be found on the ASX in ETF form.

Foolish Takeaway

Trying to predict short-term movements in the market is not a sound investment strategy in my opinion. However, many people often wonder how they can ‘short’ a share or protect their share portfolio like the professionals do. I’m not saying this is a perfect tool for everyone, but it is one super-easy way to bet against the S&P/ASX 200.

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned. Owen welcomes -- and encourages -- your feedback on Google+, LinkedIn or you can follow him on Twitter @ASXinvest.

 The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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