3 Ways To Hedge Against Iraq Uncertainty

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 |  Includes: AMZN, ANGI, CMG, CVOL, DBO, DNO, DTO, DWTI, LNKD, OIL, P, RSH, SCO, SHLD, SPY, UCO, USL, USO, UVXY, VXX, VXZ
by: Quoth the Raven

Summary

Conflict in Iraq seems to be brewing yet again.

This conflict is likely to throw a damp towel over a market that's been on fire.

While I don't think it will have long-term implications, here's a couple of ways you can soften the blow to your portfolio.

Introduction

At the end of last week, we were offered up a little taste as to what another Iraq conflict could potentially do to our U.S. markets. Stocks finished the week looking uncertain, and we awoke Monday to the Nikkei closing off 1% and the Dow Futures painting a bleak opening picture for U.S. markets.

This is coming as a result of the Islamic State of Iraq and Syria (ISIS) continuing their attempts at a takeover of the Iraqi capital. So far, President Obama has held his ground and made the statement that while U.S. intervention could potentially happen in some facet, that ground troops were unlikely.

Regardless of whether or not this is a calculated move by President Obama, and without getting into the politics behind it - I'm not a political pundit, I'm a financial writer - the U.S. seems to be somewhat uncertain about what its role is going to be in this upcoming conflict.

The country is likely divided between those that want to offer aid, and those that probably can't believe that we're talking about going into Iraq again - it must seem like the war that never ends to some.

Regardless, the uncertainty has shaken the confidence of our bull market for the time being

Here are three trades you can make to hedge yourself against the uncertainty in Iraq this week.

1. Go Long Crude Oil

While I hardly think we're going to be subject to $200/barrel crude oil, as the momo commentators on CNBC were jabbering about before last week ended, I did make a small note on my white board that going long crude could be a good hedge someone looking to protect themselves against the Iraq conflict.

Here are some of the different ETFs that can be used to trade crude.

(courtesy of etfdb.com)

Symbol Name Price Change Assets * ▼ Avg Vol YTD
USO United States Oil Fund, LP $39.12 +0.10% $610,272 2,343,708 +10.76%
SCO ProShares UltraShort DJ-UBS Crude Oil $24.55 unch $353,643 1,049,537 -22.26%
DBO PowerShares DB Oil Fund $30.35 -0.26% $310,488 65,338 +9.57%
OIL iPath Exchange Traded Notes S&P GSCI Crude Oil Total Return Index Medium-Term Notes Series A $25.73 +0.04% $223,079 270,945 +11.29%
DTO PowerShares DB Crude Oil Double Short ETN $28.11 -0.25% $124,520 122,400 -20.75%
UCO ProShares Ultra DJ-UBS Crude Oil $39.39 -0.08% $90,309 528,681 +22.25%
USL United States 12 Month Oil Fund, LP $46.68 -0.24% $58,450 4,508 +8.86%
DWTI 3x Inverse Crude ETN $22.07 -0.76% $19,161 21,492 -32.03%
DNO United States Short Oil Fund $30.24 -0.03% $12,144 7,548 -11.55%
OILZ ETRACS Oil Futures Contango ETN $25.26 unch $10,104 1,158 -0.28%
TWTI RBS Oil Trendpilot Exchange Traded Notes $21.48 +0.61% $6,874 1,065 +8.16%
OLO PowerShares DB Crude Oil Long ETN $14.86 +0.75% $6,784 2,720 +8.23%
SZO PowerShares DB Crude Oil Short ETN $34.66 -0.97% $6,307 2,525 -11.11%
OLEM iPath Pure Beta Crude Oil $45.13 unch $3,529 244 +6.89%
CRUD Teucrium WTI Crude Oil Fund $44.18 +1.73% $2,207 1,756 +9.52%
UWTI 3x Long Crude ETN $40.77 +0.12% $2,030 4,414 +32.03%
Click to enlarge

2. Lean on Your Fundamental Shorts

I spoke about the importance of always being short in my article, "Why You Should Always Be Short."

The gist is that you should, even in a bull market, always be holding some fundamental shorts - it diversifies you and gives you a broad market hedge.

Having roughly 20-40% of my portfolio short with companies that could fail even in the most bullish of the bull markets is important. I'm talking about companies like Sears (NASDAQ:SHLD), RadioShack (NYSE:RSH), Angie's List (NASDAQ:ANGI), and Pandora (NYSE:P) - as examples. Those companies don't need help to fail, they've either already done it or are so far overvalued, in the case of Pandora, they're likely to pull back. They don't really have fundamental legs to stand on.

You can add to this list all of the high multiple "momentum" stocks, that are sometimes the hardest to short. Companies like Chipotle (NYSE:CMG), Amazon (NASDAQ:AMZN) and LinkedIn (NYSE:LNKD) are the type of companies first likely to be roped in during times of unease due to their speculative valuation.

What I mean is that if you're holding companies fundamentally short at all times (aside from your long positions), you're effectively doing two things:

1. Placing a calculated bet on the fundamentals of a company that it'll go down. If it does, you make money.

2. Buying broad market protection in the case of the macro markets getting spooked - specifically from something like this type of event coming out of nowhere.

3. Stake A Short-Term Volatility Position

One item that has been at record lows during this bull market has been the VIX. The VIX is tradable through ETNs like VXX.

What is VXX and how does it work?

The VXX is an Exchange Traded Fund used to replicate, net of expenses, the S&P 500 VIX short-term futures total return index. It's an index that offers exposure to a daily rolling long position in the first and second-month VIX futures. In addition, the VXX reflects the implied volatility of the SPY index at points along the volatility forward curve.

The index futures roll continuously throughout each month from the first-month VIX futures contract into the second month VIX futures contract.

The VIX (Chicago Board Options Exchange Market Volatility Index), commonly referred to as the Fear Index, measures the implied volatility of index options traded. Basically, it represents the market's expectation of volatility in the coming thirty-day period.

In a bull market, like we've currently been in over the last five years, the VIX generally rides nice and low. In a bear market, or in the midst of global unease of some sort - like the government shutdown - the VIX is capable of spiking upwards.

The VXX is a good short-term tool - read it again, short-term tool - to make money off volatility that you may see coming. You do not want to buy and hold VXX, as it's an instrument that is perpetually making its way downward with the exception of small term spikes up.

How You Can Trade Volatility:

  • Go long volatility ETFs, like VXX
  • Buy ETPs that track the VIX, like UVXY and CVOL
  • Buy VIX call options
  • Buy call options for VXV
  • Buy S&P VIX Mid-Term Futures (NYSEARCA:VXZ)
  • Buy S&P 500 VIX ETF listed as VIXS

Conclusion

Regardless of whether or not this uncertainty lasts for a little while, you should be able to have part of your portfolio that rises when the markets are ticking down. However, I'm hoping for this "conflict" to have the same effect as when Putin moved into Ukraine - the markets cared for a couple days, and went on resuming being full throttle bulls.

I hope this article shares some perspective traders on how to hedge. Best of luck to all investors.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.