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Use ETFs to Trade the Double Dip

Time to price put options on banking, homebuilder ETFs

Data has been coming in showing a slowdown in the economy and the double dip recession is about to hit the US — if not in 2011 Q4, then 2012 Q1, barring some unforeseen action by the Fed. Can you trade this? Yes.

The trade is the market itself and its weakest components — the banks as represented by the Financial Select SPDR (NYSE: XLF) and the home builders as represented by the SPDR S&P Homebuilders (NYSE: XHB). In both of these exchange-traded funds options trading investors want to look at very long term puts and remember — you get the most leverage with out-of-the-money puts.

Plus a couple of longs, companies that are flourishing as consumers spend their money more wisely – Polo Ralph Lauren (NYSE: RL) is a winner here. You should look at calls that expire late in the year, after the next two earnings announcements.

First, why am I so gloomy?

  • Housing: The housing market bust makes this Great Recession different from all the others that followed World War II.  Single family housing starts, reported this week, are at one third of peak; Fed interest rates are at zero; one fourth of Americans are under water on their mortgages, another 10%-15% almost there, meaning they cannot move; one in four Americans has a lousy credit score. Throw in the 12% of Americans late on their mortgages and you have foreclosures to the tune of seven million — and that means too much inventory and too few starts until 2014 – 2015.

  • Unemployment: The number is officially above 9%. Add in the officially underemployed and stopped looking and we are closer to 20%. Add in early retirements and “disability” claims — they have skyrocketed – and it is between 20% and 23%. No economy can grow with this kind of unemployment.
  • Consumer Spending: Employment drives national income. The number of people working has shrunk for almost three years and shows no signs of increasing. Less income means less spending, less spending means lower corporate revenues and profits over time.

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“Use ETFs to Trade the Double Dip” continued.

  • Business Spending/Exports: Sorry, but who cares? Consumers are two thirds of the economy. If we doubled exports it would decrease unemployment by no more than a point or two. Jobs drive the economy, corporate profits and stock multiples.

What to do?

First, I see a stalled and then a declining market. This may take a quarter or two to be evident but be ready for a decline. Before then, I see the market rising to 1400 in the S&P 500 and then the decline begins, maybe sooner. I would not play the short side until the market breaks 1285-1300 in the S&P 500.

Find more option analysis and trading ideas at Options Trading Strategies.

Second, banks have no earnings power and home builders have even less so as a segment they are grossly overvalued. The short plays here are puts on the major ETFs for these segments. Look at the long term — 2012 or longer — on both of these. They may go against you for a while but this is the play when the market wakes up to economic reality. As I mentioned, you get the most leverage with out-of-the-money puts.

Third, there are long plays here. I think a real winner is the “luxury” consumer segment that also caters to folks like you and me. Remember, the mass market for diamonds was created during the depths of the Great Depression. Ralph Lauren is a leader with its wonderful multi-tiered strategy.  Consumers are spending money on that little man on the horse because of real quality and perceived value. Look at yearend calls out-of-the-money, and give yourself a couple of earnings announcements to pop the stock.

Michael Shulman uses simple trading tactics to make solid, profitable investments in falling stocks in his Short-Side Trader service.

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