Short the Market with These 19 ETF Option Strategies

As recently charted in my blog post here, I believed (and still believe) the market is due for a correction. The chart is a clear head and shoulders pattern of the S&P 500 SPDR (SPY). Some of the ways I've been hedging my portfolio, is by using the leveraged short ETFs.

One strategy I've been using on these short ETFs is the Buy/Write option strategy, which hedges my overall portfolio on the downside, and gives me protection on the short position in case the market moves higher.

You'll need to understand options in order to consider the ideas discussed below. To learn about opening and closing these positions and options in general check out my blog or click here.

All data is as of pre-market Wednesday July 8, 2009.

Buy/Write Option Strategy #1: Buy the UltraShort Basic Materials ProShares (SMN) ETF and sell the July 22.50 call option. Assuming you get called away this will return 7.4% in 10 days. If you don't get called away the premium received gives you a 4% downside protection.

Buy/Write Option Strategy #2: Buy the UltraShort DJ-AIG Crude Oil ProShares (SCO) ETF and sell the July 22 call option. Assuming you get called away this will return 8.4% in 10 days. If you don't get called away the premium received gives you a 3.5% downside protection.

Buy/Write Option Strategy #3: Buy the UltraShort Dow 30 ProShares (DXD) ETF and sell the July 54 call option. Assuming you get called away this will return 6.4% in 10 days. If you don't get called away the premium received gives you a 1.6% downside protection.

Buy/Write Option Strategy #4: Buy the UltraShort Financials ProShares (SKF) ETF and sell the July 49 call option. Assuming you get called away this will return 9.2% in 10 days. If you don't get called away the premium received gives you a 3% downside protection.

Buy/Write Option Strategy #5: Buy the UltraShort Gold ProShares (GLL) ETF and sell the July 15 call option. Assuming you get called away this will return 1.6% in 10 days. If you don't get called away the premium received gives you a 4.2% downside protection. This is a deflationary hedge, however I am more concerned about longer term inflation. A good way to hedge against long term inflation is the GOLD SPDR (GLD).

Buy/Write Option Strategy #6: Buy the UltraShort Industrials ProShares (SIJ) ETF and sell the July 50 call option. Assuming you get called away this will return 6.1% in 10 days. If you don't get called away the premium received gives you a 3.1% downside protection.

Buy/Write Option Strategy #7: Buy the UltraShort Oil & Gas ProShares (DUG) ETF and sell the July 22 call option. Assuming you get called away this will return 5.5% in 10 days. If you don't get called away the premium received gives you a 3.8% downside protection.

Buy/Write Option Strategy #8: Buy the UltraShort QQQ ProShares (QID) ETF and sell the July 37 call option. Assuming you get called away this will return 6.6% in 10 days. If you don't get called away the premium received gives you a 2.1% downside protection.

Buy/Write Option Strategy #9: Buy the UltraShort Real Estate ProShares (SRS) ETF and sell the July 22.50 call option. Assuming you get called away this will return 8.7% in 10 days. If you don't get called away the premium received gives you a 4.2% downside protection.

Buy/Write Option Strategy #10: Buy the UltraShort Russell 2000 ProShares (TWM) ETF and sell the July 49 call option. Assuming you get called away this will return 7.4% in 10 days. If you don't get called away the premium received gives you a 2.6% downside protection.

Buy/Write Option Strategy #11: Buy the UltraShort S&P 500 ProShares (SDS) ETF and sell the July 63 call option. Assuming you get called away this will return 6.7% in 10 days. If you don't get called away the premium received gives you a 2% downside protection.

Buy/Write Option Strategy #12: Buy the UltraShort Semiconductor ProShares (SSG) ETF and sell the July 40 call option. Assuming you get called away this will return 8.8% in 10 days. If you don't get called away the premium received gives you a 2.2% downside protection.

Buy/Write Option Strategy #13: Buy the UltraShort Technology ProShares (REW) ETF and sell the July 45 call option. Assuming you get called away this will return 4.7% in 10 days. If you don't get called away the premium received gives you a 1.5% downside protection.

Buy/Write Option Strategy #14: Buy the Direxion Daily Devlpd Mrkts Bear 3X Shares (DPK) ETF and sell the July 40 call option. Assuming you get called away this will return 17.6% in 10 days. If you don't get called away the premium received gives you a 4.9% downside protection.

Buy/Write Option Strategy #15: Buy the Direxion Daily Energy Bear 3X Shares (ERY) ETF and sell the July 30 call option. Assuming you get called away this will return 13.5% in 10 days. If you don't get called away the premium received gives you a 3.6% downside protection.

Buy/Write Option Strategy #16: Buy the Direxion Daily Financial Bear 3X Shares (FAZ) ETF and sell the July 6 call option. Assuming you get called away this will return 14.7% in 10 days. If you don't get called away the premium received gives you a 3.3% downside protection.

Buy/Write Option Strategy #17: Buy the Direxion Daily Large Cap Bear 3X Shares (BGZ) ETF and sell the July 42 call option. Assuming you get called away this will return 8.8% in 10 days. If you don't get called away the premium received gives you a 3.4% downside protection.

Buy/Write Option Strategy #18: Buy the Direxion Daily Small Cap Bear 3X Shares (TZA) ETF and sell the July 30 call option. Assuming you get called away this will return 18.5% in 10 days. If you don't get called away the premium received gives you a 2.4% downside protection.

Buy/Write Option Strategy #19: Buy the Direxion Daily Technology Bear 3X Shares (TYP) ETF and sell the July 25 call option. Assuming you get called away this will return 6.8% in 10 days. If you don't get called away the premium received gives you a 3.9% downside protection.

These options expire in 10 days (July 18, 2009) therefore the last trading day is Friday July 17, 2009. As you can see the greater the return, the lower the downside protection. I used a more bearish scenario based on the higher strike prices, in the case the option expires out of the money I just write it out for a similar strike for the following month. These ETFs bring very high premiums, but in my opinion should not be written out or held in your portfolio for extensive time periods (see why here).

Of these 19 Buy/Write option strategies the ones that look most attractive to me are the short financial ETFs such as the UltraShort Financials ProShares (SKF) and the Direxion Daily Financial Bear 3X Shares (FAZ). The reason for this is because I think the financials are much over bought and will experience the greatest pull back from a market correction. The top daily holdings for the FAS (which is the Direxion 3X Bull Financials, inverse of the FAZ) are: JPMorgan (JPM), Wells Fargo (WFC), Bank of America (BAC), Goldman Sachs (GS), Morgan Stanley (MS), Bank of NY Mellon (BK), US Bancorp (USB), and American Express (AXP); and if you look at the table below you'll see that these 8 stocks have moved an average of 136.7% since the current market bottom on March 6, 2009.

Unlike the FAS, the FAZ does not have an easy to understand daily list of holdings, but it seeks to return 3X the inverse of the basket of financials in the FAS.

And as the table above shows these top holdings have had massive gains since March 6, and assuming the market has a correction (I can see the S&P 500 down to the 850 range, the Dow down to the 8000 range, and the NASDAQ down to the 1680 range), I believe the financials will experience the greatest pull back.

However the Buy/Write option strategy gives you downside protection as well in case the market gains in the coming 10 days. If the market moves more or less sideways this is also a winning strategy, as the premiums for these leveraged ETFs have large time values, which will deteriorate closer to the option expiration.

If you're more bullish/bearish you’ll want to adjust the strike price accordingly. If you’re even more bearish, write further out of the money calls; you won't have as much downside protection, but you'll give yourself a greater possible return.

This strategy is a great way to hedge your portfolio and could return a large gain in just 10 days (time until these options expire). Option volumes have exploded over the past 5 years because it is a great way to hedge your portfolio (see chart here).

For your convenience I have ranked these leveraged ETFs by % Return in the printable spreadsheet available on my blog here.

Disclosure: Long AXP, BGZ, FAZ, GS

Comments

[TCK:]

I agree with the sentiment, however I prefer to short the 2X or 3X longs rather than buy/write on the shorts. These types of ETF's do not accurately track movement of the holdings except on a daily basis

For example, I am currently long the Aug 38/30 put spread on the QLD. Also long the July 10/7.5 put spread on the FAS. Also as a side note, these positions can be held in an IRA account.

Be careful of the FAS and FAZ as these will have a reverse stock split on July 8th. The lack of efficiency in these products has been widely written about and without the reverse splits all ( long and short ) would eventually go to near zero.

Related article;

www.thestreet.com/_yah...

Jul 08 08:48 AM

[Bar Lock:]

Lots of ideas worth looking at. Good analysis.

Jul 08 09:37 AM

[ENEM:]

I applaud TCK’s idea. May I request TCK for clarification how to proceed in following situation:
For QLD, If I sell August 38 PUT & buy August 30 Put . When QLD goes down to 34, I cannot BUY TO CLOSE 38 PUT as this would result in loss.
What is the course of action in such case



On Jul 08 08:48 AM TCK wrote:

> I agree with the sentiment, however I prefer to short the 2X or 3X
> longs rather than buy/write on the shorts. These types of ETF's do
> not accurately track movement of the holdings except on a daily basis
>
>
> For example, I am currently long the Aug 38/30 put spread on the
> QLD. Also long the July 10/7.5 put spread on the FAS. Also as a side
> note, these positions can be held in an IRA account.
>
> Be careful of the FAS and FAZ as these will have a reverse stock
> split on July 8th. The lack of efficiency in these products has been
> widely written about and without the reverse splits all ( long and
> short ) would eventually go to near zero.
>
> Related article;
>
> www.thestreet.com/_yah...;cm_cat=FREE&c...

Jul 08 04:09 PM

[Marco Hickey:]

Thanks today would be a good day to open these on market strength (weakness in these shorts).


On Jul 08 09:37 AM Bar Lock wrote:

> Lots of ideas worth looking at. Good analysis.

Jul 09 01:42 PM

[MoeMan929:]

What happens with the options now that FAZ has reverse split? Supposing you sold 4 contracts (=400 shares). Now you own 40 shares and the contract becomes 0.4??

Jul 10 03:28 PM

[Marco Hickey:]

The contracts become non-standard option contracts. Each contract (1 contract) is now for 20 shares of FAS and 10 shares of FAZ. You would have received these in place of your standard option contracts before the split.


On Jul 10 03:28 PM User 445042 wrote:

> What happens with the options now that FAZ has reverse split? Supposing
> you sold 4 contracts (=400 shares). Now you own 40 shares and the
> contract becomes 0.4??

Jul 10 04:12 PM

[MoeMan929:]

Man, looks like these most of these ideas will end up as big-time losers judging by the way this week is going..

Jul 15 03:17 PM

[Berto:]

Wow. You got railed, dude. I was bearish, but never got in - support in the 875/880 range NEVER got fully broken. Pays to wait for momentum and not jump the gun.

When everyone and their mom is talking about "head and shoulders" (look at the google trends!) and shorting the market, it's time to step back and count your cash for a few more weeks.

Jul 16 12:20 AM