Hrm. What to do?

Wow, it took until Wednesday for the market to show a little volatility on the debt ceiling overhang.

I'm not sure what to do.

I shorted some S&P (while buying some off-setting call options) earlier this week. The trade is now in the money, but it's only ~6% of the portfolio and I'm still sitting on a lot of cash.

Either way I don't see how the market's go up from here. Even if the default is resolved without a downgrade (which in itself should cause nearly all assets to reprice lower as you would need a higher discount rate) there's no way unemployment can go down with this type of uncertainty.  One WSJ article indicated that GE was sitting on record cash balances (Bloomberg says $136bn) due to the macro uncertainties outstanding, including the U.S. debt ceiling. No company in their right mind will invest in labor or capital when the liquidity market itself is at risk!

Strategy

I guess my concern with scaling up the bet is how much can I really win?

If it's in a tax account all profits will be cut by 50% due to the short-term nature of the trade.

If it's in a tax free account I need to consider index inverse vehicles that have tracking error and may not function properly if the treasury market defaults. Who the hell knows, given that their value is based on derivatives with counter-party risk. And seriously, if the treasury market defaults, who isn't a counter party risk?

That said, I'd rather have my cash short the S&P (even if it's taxed at 50%) than in treasuries that only have downside (not getting any yield in the next 6 days).

Conclusion

I'm not a specialist at shorting the market. I'm a security analyst, not an index day trader.  I'm only doing this to protect my capital.  Once the ceiling is raised, which I hope it will, I will unwind these positions as my cash / money market funds will no longer be at risk.  At which point, if I want to go short, I'll look for individual stocks or a basket of companies to short. 

In a hypothetical default scenario, I would imagine that the most I would lose in the money market is 10-20%.  I would expect the U.S. government to say that within days all the post-petition interest will be paid and old defaulted bonds will receive new bonds at 100 cent dollar face value.

This loss, however, due to the sheer illiquidity of the money market, would pale in comparison to how much the equity market and fixed income market will lose creating the opportunity for buying $0.50 dollars or even $0.25 dollars if I'm lucky (and assuming that the stock market is even open - which I doubt it would be).

This is a crazy range of scenarios, my stomach is upset just thinking about it.