4 Ways To Profit From Stock Market Panic

Includes: DIA, SDS, SH, SPXS, SPY, TZA
by: Christopher F. Davis

Is the market bound to sell off from here? The answer is most likely yes, we are due for a pullback, and the action in Cyprus last week, the gloomy jobs report on Friday and the upcoming earnings season, if weak, could be catalysts for a strong sell-off. Some believe we could see Dow 12,000 again before we see Dow 15,000. Likewise, we could see the S&P 500 at 1350 before 1600.

Right now, the Dow Jones ETF (NYSEARCA:DIA) is at 5 year highs at $144.95 and SPDR S&P500 ETF (NYSEARCA:SPY) is near its highs at 154.90. The question of whether the rally is over is on each investor's mind, both bulls and bears alike. While the economy is getting slightly better, we have to be concerned about the jobs number. Most of all, many professionals I speak to believe earnings estimates are too high and will not be beaten frequently this quarter. While I cannot predict if this rally is coming to an end or not, a correction (which is overdue) will eventually occur. That's a fact.

When the correction starts, it could happen over the course of a few weeks. Thus, traders may want to put on some bearish positions to protect or even continue to grow capital. Those who are bearish could consider selling stock, selling covered calls on their positions, shorting stocks, buying puts or investing in a volatility or bear fund. While each of these approaches has its respective benefits and risks, in this article, I want to highlight four quick-pick ETF bear funds that could provide great short-term returns in the event of a market sell-off.

ProShares Short S&P 500 (SH): This ETF seeks daily investment results that correspond to the inverse of the daily performance of the S&P 500 index. As most investors know, the S&P 500 index is a measure of large-cap United States stock performance. It is a capitalization weighted index of 500 United States operating companies and selected real estate investment trusts. SH attempts to invest at least 80% of its net assets, including any borrowings for investment purposes, to investments that, in combination, have economic characteristics that are inverse to those of the index. It intends to invest assets not invested in financial instruments, in debt instruments and/or money market instruments. The fund intends to concentrate its investments in a particular industry or group of industries to approximately the same extent the underlying index is concentrated.

SH is a low risk way to take a bearish position. It should be noted that because there is an expense fee associated with the ETF (like most ETFs) and that it seeks daily results, the investment could lose value over time in a stagnant market. The SH has an expense ratio of 0.89% annually, meaning $89 on a $10,000 investment goes to fees annually. SH currently trades at $30.92 on approximately 2.5 million shares exchanging hands daily. SH has a 52-week range of $30.53-$39.37.

ProShares UltraShort S&P 500 (SDS): For those with slightly more risk appetite seeking to make a leverage bet to the downside, SDS could be a profitable play. This leveraged fund seeks daily investment results that correspond to twice the inverse of the daily performance of the S&P 500. SDS invests in common stock issued by public companies. SDS also invests in derivatives, which are financial instruments whose value is derived from the value of an underlying asset, interest rate or index. SDS recently underwent a one-for-four reverse split to bolster the share price, as the nearly four-year bull market took its toll on this fund's value. The value of shares not only depreciated from being sold down with other bearish plays during the bull market, but was also hurt by its expense ratio (0.89%) and the fact that it is adjusted daily. Funds that seek daily performance never track the long-term performance of an underlying index due to a concept known as "slippage." More on that can be found here. Despite this fact, daily leveraged funds such as the SDS, in periods of panic and bearishness, perform exceptionally well. Thus, a well-timed position can be very profitable. SDS currently trades at $44.79 a share. SDS has average daily volume of 9.2 million shares exchanging hands. SDS has a 52-week range of $43.66-$73.04.

Direxion Daily S&P 500 Bear 3x ETF (SPXS): For those with the highest appetite for risk, besides investors who are willing to short stocks, the SPXS can be considered for heavily leveraged bearish exposure. SPXS, formerly the Direxion Daily Large Cap Bear 3X fund, seeks daily investment results before fees and expenses of 300% of the inverse of the price performance of the S&P 500 Index. As with other funds, there is no guarantee the fund will meet its stated investment objective and is subject to slippage as described above. The fund also has a higher 1.14% annual expense ratio.

Under normal circumstances, SPXS management creates short positions by investing at least 80% of its net assets in: futures contracts; options on securities, indices and futures contracts; equity caps, collars and floors; swap agreements; forward contracts; short positions; reverse repurchase agreements; ETFs; and other financial instruments that, in combination, provide leveraged and unleveraged exposure to the S&P 500. Given this approach, in times of market sell-offs, the SPXS will deliver outsized returns. Thus, this fund should be considered by those who seek to profit from panic that could result from a fast sell-off that jolts the market.

SPXS currently trades at $12.61 a share. SPXS has average daily volume of 2.4 million shares exchanging hands. SPXS has a 52-week trading range of $12.14-$26.83.

Direxion Daily Small Cap Bear 3X Shares (TZA): This is my favorite way to invest in a bear market short term. TZA seeks daily investment results of 300% of the inverse of the price performance of the Russell 2000 Index (also known as the small cap index). The Russell 2000 measures the performance of the small-cap segment of the United States equity universe and consists of the smallest 2,000 companies in the Russell 3000 Index, representing approximately 10% of the total market capitalization of the Russell 3000 Index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

TZA actually does not invest in equity securities or stocks. What TZA does is creates short positions by investing at least 80% of its net assets in financial instruments to provide leveraged and unleveraged exposure to the small cap index and the remainder in money market instruments. TZA recently underwent a reverse split, thus it seems to be trading higher than in the past. It now currently trades at $40.03 a share on average daily volume of 3.9 million shares. TZA has a 52-week range of $36.56-$98.64.

Conclusion: Many approaches exist to position accordingly for market panic. While we have had a great bull run in the last few months and the last few years as a whole, macro news such as that out of Cyprus, bad jobs numbers and poor earnings could be what finally triggers the next selloff. I suspect markets will react negatively to continued bad news, and the aforementioned bearish funds will perform very well for short-term gains in response to the market panic that will ensue.

Disclaimer: I am not recommending investors to be bullish, bearish or neutral. This article is for informational purposes only and highlights funds one can consider in the event or anticipation of short-term bearishness. It is not a recommendation to buy or sell any of the aforementioned assets.

Disclosure: I am short SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.