Investing In A Charlie Brown Market: Options In Leveraged ETFs

Includes: TNA, TZA
by: Ketan Desai

This is a Charlie Brown market. Just as bulls are sure of their argument, bad news comes from Europe, earnings, labor statistics, or the economy in general. And as bears see their viewpoint being vindicated, "good" news comes from Europe, earnings, labor or the economy. And if one thought this was a trading range market, the stocks proceed to take out their trading range lows, only to then take out their trading range highs. Lucy is everywhere. What to do in such a market?

Evaluating one such strategy, I had written on leveraged ETFs on Oct 6. The premise of the article was that shorting these leveraged ETF may be a way forward, considering the way the ETFs are re-calculated at the end of each day. Specifically, the example given was to be short both Direxion Russell 2000 Bearish 3X ETF (NYSEARCA:TZA) and Direxion Russell 2000 Bullish 3X ETF (NYSEARCA:TNA), which are respectively 3x bearish and 3x bullish on small cap stocks. A couple of reader's comments from that article were worth following on. One reader said the he could not find a broker who would let him short these ETFs, and another suggested using options, specifically selling covered calls. Naturally, it was worth evaluating if such a strategy was worthwhile, especially for those who could not short these ETFs.

So, in a hypothetical scenario, I bought 500 shares of TZA and TNA and sold 5 covered calls on each. On Oct 6, TZA was at $45 and TNA was at $36.13, the total cost of buying them was $40,634.48. Covered calls could then be sold for each - and the trick here being which month and what price. Since I wanted to find out the results fast, and because calls lose their value faster closer to expiration, I chose October 22. For the strike price, I chose $5 above buying price for each. Thus, I sold 5 Oct 22 TZA 50 calls for $3.65 each and 5 TNA 40 calls for $2.05 each. The total gains from these calls was $2822.38, reducing the cost basis to $37,812.10.

On Friday, Oct 21, TZA was at $35.81. Thus, the calls expired worthless, and TZA sold at market. TNA was at $42.85, so the calls were in the money, and TNA was called away at $40. The total sale price of 500 shares of TZA and TNA came to $37, 905.

The trade netted a profit of $37,905 - $37,812.10 or $92.90, a 0.24% return in two weeks. As an academic exercise, If one were to annualize this, it would come to about 6.7%. There are plenty of caveats in this strategy, such as choosing the strike price and month. But for what it is worth, it led to a small profit. In this Charlie Brown market, that is welcome.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.