Many professionals and analysts still believe earnings estimates are too high for this quarter and next. Thus far, companies reporting earnings have delivered less than stellar results. Add to this the looming fiscal cliff and of course the highly contentious U.S. election today and you have a recipe for extreme short-term fear. These events will likely exert pressure on markets that have essentially been propped up by central bank actions. Thus, traders may want to consider taking some bearish action should market panic ensue. Those who are bearish could consider selling stock, selling covered calls on their positions, shorting stocks, buying puts or investing in a bear fund. While each of these approaches has its respective benefits and risks, in this article I want to highlight four ETFs that could provide great returns in the event of a market sell-off on fear of uncertainty, disappointing earnings or continued international news that spooks markets.
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 $15.60 a share on average daily volume of 20 million shares. In the last month TZA is up 7.3% compared with the ETF that tracks the Russell 2000 index (NYSEARCA:IWM), which is down 2.8%. TZA has a 52-week range of $13.35-$39.68.
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 $34.53 on approximately 3.3 million shares exchanging hands daily. SH is up 2.9% in the last month, while the S&P 500, as measured by the (NYSEARCA:SPY) is down 2.9%. SH has a 52-week range of $33.34-$44.21.
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 near its one-year lows at $55.90 a share. SDS has average daily volume of 4.0 million shares exchanging hands. In the last month SDS is up 5.7% while the SPY is down 2.9%. 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 $17.78 a share. SPXS has average daily volume of 1.5 million shares exchanging hands. In the last month SPXS is up 8.2 % while the SPY is down 2.9%. SPXS has a 52-week trading range of $16.07-$39.26.
Bottom line: 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 reports, turmoil in Europe, the US Presidential election and the looming fiscal cliff will dictate the direction of the market. The aforementioned funds perform very well in the events of market sell-offs.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TZA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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.