It seems like the signs are everywhere indicating a bubble in China. Canadian Capitalist had a post about it a few weeks ago, I’ll let you go check it out if you’re interested about what is perhaps causing the bubble. We’re more concerned today about ways for investors to profit from it.

The question one must ask is, short of shorting a China market ETF, how can one short China?

First of all, I want to caution people to not simply go out and short a China ETF. Sure, on the surface it seems like an effective way to bet against the market. The problem with that strategy is that if it goes wrong, it goes horribly wrong. Oftentimes with bubbles, early naysayers can start to call a top years before the market finally figures out what’s going on. In the meantime, the asset class is often up┬ásubstantially from earlier levels. If you’re early to the party, naked shorting can be very, very painful.

The other disadvantage to shorting is unless you’re a short term trader, your profit is limited to 100% of your investment. The downside is, in theory at least, unlimited. A stock can go up forever, yet it can only go down to zero. There are other ways to short China.

The easiest is to buy a long term put option on the Chinese market. A put gives you the right, but not the obligation to sell a stock (or in this case, an index) for a certain price on a certain date. An investor pays a premium for the right to do this. If the Chinese market is up above the strike price when the time comes, the investor is only out the original premium. Thus the downside is only minimal.

(Please note: I don’t really understand put options. You should seek advice from people smarter than me if you want to buy them)

I have a slightly different strategy for shorting China. I’m not going to.

Instead of trying to actively short the market, I’m just going to avoid any stock that has a large Chinese factor to it. If a company is counting on an emerging middle class in China to grow the bottom line, I just won’t invest in that stock. Same thing with any of the Chinese resource companies or companies that manufacture the majority of their products there. While I don’t think production is going to move away from China anytime soon (at least in any meaningful way) I want to avoid the country, just in case.

How about you? Do you plan on trying to short China? Or any other bubbles that may be out there?

Tell everyone, yo!