Last week the European Central Bank announced an unlimited short-term bond-buying program with some conditions, helping to allay fears that it would not do all it can to save the euro. Today the German High Court upheld the decision to back the bailout fund with few reservations beyond reviewing any proposed increases to the bailout. The U.S. markets gained some traction on the news even though volume is relatively light thus far. With last week's pitiful jobs number and downward revisions of prior months, many believe that the Federal Reserve must move on QE3. In my opinion, the markets all but fully expect QE3 and they expect it to be announced tomorrow. If it does not announce QE3, I think we will finally see an overdue sell-off ensue, as I just can't see the markets accepting no action and maintaining current market levels. It would clearly be a disappointment. Thus traders may want to put on some bearish positions. Those who are bearish could consider selling stock, selling covered calls on their positions, shorting stocks, buying puts or by 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 six ETFs, three volatility and three bear funds, that could provide great short-term returns in the event of a market sell-off on disappointing news.
Ipath S&P 500 Short-Term VIX futures ETN (VXX): The Chicago Board Options Exchange Market Volatility Index or the VIX, is a popular measure of the implied volatility of S&P 500 market index. You may hear it often referred to as the fear gauge or the fear index. The VIX is a measure that is supposed to represent the market's expectation of stock market volatility over the next 30-day period. The VXX is a fund that is one of the better ways to track the VIX (which is not directly available to invest in) in my opinion. This investment seeks to replicate, net of expenses, the S&P 500 VIX Short-Term Futures Total Return Index. The index offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500 index at various 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 fund has an annual expense ratio of 0.89%, is currently trading at $9.71, and has a 52-week trading range of $9.24-$59.18.
ProShares Ultra VIX Short-Term Fut ETF (UVXY): This is my favorite play when I expect short-term volatility to spike. The investment fund seeks to replicate (net of expenses) twice the return of the S&P 500 VIX Short-Term Futures index for a single day. The index measures the movements of a combination of VIX futures and is designed to track changes in the expectation for one month in the future. The fund has an expense ratio of 1.41%, currently trades at $37.00 and has a 52 week range of $33.65-$2444.80. This wide range has been a result of multiple reverse stock splits conducted by the fund's managers.
VelocityShares Daily 2x VIX ST ETN (TVIX): This is my least favorite, but still effective play on very short term volatility. The return on this fund is linked to twice the daily performance of the S&P 500 VIX Short-Term Futures. It was designed to provide investors with exposure to one or more maturities of futures contracts on the VIX, which reflects implied volatility of the S&P 500 Index at various points along the volatility forward curve. The calculation of the VIX is based on prices of put and call options on the S&P 500 Index. This fund has a 1.65% expense ratio and currently trades at $1.82 and has a 52 week range of $1.71-$109.17.
Right now, volatility is quite low and a few pieces of bad news starting with a disappointment out of the Federal Reserve could cause this market's volatility will spike. Consider picking up some units of these indexes or some in the money call options as a short-term play on anticipated volatility, should you expect disappointment.
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 currently trades at a one-year low at levels of $14.64 a share on average daily volume of 20 million shares. In the last month TZA is down 15.9% compared with the ETF that tracks the Russell 2000 index (IWM), which is up 5.6%. TZA is near the bottom of its 52-week range of $14.57-$63.87.
ProShares Short S&P500 (SH): This ETF seeks "daily investment results that correspond to the inverse of the daily performance of the S&P 500 index. 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 as the Index is so concentrated."
SH currently trades at $34.21 on approximately 3.3 million shares exchange hands daily. SH is down 2.6% in the last month, while the S&P 500, as measured by the (SPY) is up 2.5%. SH has a 52-week range of $34.17-$48.48.
ProShares UltraShort S&P500 (SDS): This leveraged fund seeks "daily investment results that correspond to twice the inverse of the daily performance of the S&P 500. Recall the S&P 500 is "a float-adjusted, market capitalization-weighted index of 500 United States operating companies and real estate investment trusts selected through a process that factors criteria, such as liquidity, price, market capitalization and financial viability." 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 currently trades at its one-year lows at $13.74 a share. SDS has average daily volume of 18.5 million shares exchanging hands. In the last month SDS is down 5.2% while the SPY is up 2.5%. SDS is at the bottom of its 52-week range of $13.71-$28.16.
Bottom line: It's a lot easier to make the bear case than it is to make the bull case right now in my opinion. There are lots of ways to prepare for a potential short-term bear market including selling covered calls, buying puts, shorting stocks and stock indices, or just plain old selling equities to raise cash. While Federal Reserve action seems likely I believe it would be prudent to consider a "no fed action on QE3" strategy. I think a short-term move to bet against QE3 is by playing volatility or a bearish ETF fund. Both the TZA bear fund and the UVXY volatility fund are my favorites to consider for short-term market selloffs and/or panic.
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 volatility and bearishness. It is not a recommendation to buy or sell any of the aforementioned assets.