Stocks have had a strong month as central bank action has bolstered equity markets. First the European Central Bank announced an unlimited short-term bond-buying program with some conditions, reinforcing its position to do all it can to save the euro. Then the German High Court upheld the decision to back the bailout fund with few reservations beyond reviewing any proposed increases to the bailout. Following this, Ben Bernanke and the U.S. Federal Reserve announced a massive third round of quantitative easing, aka QE3, consisting of buying $40 billion in mortgage assets monthly until unemployment improves. Even the Bank of Japan recently hopped on board the central bank stimulus train and announced its own round of easing. Now that the allure of central bank action has passed, earnings and economics reports will return to the focus of investors. The most recent jobs report, which showed unemployment dipped to 7.8%, was weak overall, including the addition of only 114,000 jobs. The markets digested the news and began selling throughout the day following this announcement. Many professionals believe earnings estimates are too high and will not be beat frequently this quarter. In addition there is the looming fiscal cliff and a highly contentious election to consider in the U.S. in a few weeks. 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 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 seven ETFs, three volatility and four bear funds that could provide great short-term returns in the event of a market sell-off on disappointing earnings or international 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. VXX recently underwent a major one for four reverse split to increase share value. The fund has an annual expense ratio of 0.89%, is currently trading at $34.12, and has a 52-week trading range of $33.12-$198.04.
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 $27.78 and has a 52 week range of $26.20-$1656.00. 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 $1.39 and has a 52 week range of $1.29-$72.12.
Right now, volatility is quite low and a few pieces of bad news starting with lackluster earnings or more economic contagion in Europe could spark a selloff. Further, volatility is likely to spike on political news as well. 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 a selloff. Do not however buy and hold these funds as the contango associated with volatility futures contracts eats into the share price over time. They are short-term plays only.
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 $14.51 a share on average daily volume of 20 million shares. In the last month TZA is down 3.5% compared with the ETF that tracks the Russell 2000 index (IWM), which is up 0.7%. TZA has a 52-week range of $13.35-$44.95.
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 $33.57 on approximately 3.3 million shares exchanging hands daily. SH is down 2.4% in the last month, while the S&P 500, as measured by the (SPY) is up 1.7%. SH has a 52-week range of $33.33-$44.22.
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 recently underwent a one for four reverse split. It currently trades at its one-year lows at $52.92 a share. SDS has average daily volume of 4.1 million shares exchanging hands. In the last month SDS is down 4.5% while the SPY is up 1.7%. SDS has a 52-week range of $52.12-$93.60.
Direxion Daily S&P 500 Bear 3x ETF (SPXS): 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. The fund has a 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.
SPXS currently trades near its one-year lows at $16.43 a share. SPXS has average daily volume of 1.48 million shares exchanging hands. In the last month SPXS is down 6.8 % while the SPY is up 1.7%. SPXS has a 52-week trading range of $16.03-$40.84.
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 central bank action has bolstered markets, I believe earnings, trouble in Europe and the upcoming election will dictate the direction of the market. I think a short-term move to insure your portfolio against a selloff is by playing volatility or trading 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.
Disclosure: I am long TZA.