The market has had the case of the jitters for the last 30 days or so, as traders decided to take money off the table in the face of the Greek threat to pull out of the eurozone, Spain’s debt problems and now the likely spread of the European recession around the rest of the world. The markets may have calmed down this week, but a TON of selling pressure continues to build and any more negative news from Europe and the economy could ignite another round of sell-offs again next week.
Now, there are a couple of things a trader can do in the face of the recent downtrend. You can sell your long positions and hunker down in fear, or you can take advantage of the selling with exchange-traded funds (ETFs) designed to move higher when stocks are in descent.
I prefer to do the latter, but before doing so we have to know which of these inverse, or short, ETFs give us the best chance at making money.
1) ProShares Short S&P 500
If you think the recent selling in equities is a harbinger of more widespread pain to come, then your broadest bet is the ProShares Short S&P 500 (NYSE:SH). This inverse ETF is designed to move in the opposite direction of the broad market S&P 500 Index. Basically, if the S&P 500 were to go into correction mode, falling another 5% or so from where it trades right now, then SH would gain about 5%. Putting SH in your trading portfolio gives you an easy, low-cost way to hedge your long portfolio against further selling.
2) ProShares UltraShort S&P 500
More intrepid traders might want to double down on their short bets against the broad market, and doing so is easy with the ProShares UltraShort S&P 500 (NYSE:SDS). This fund is designed to deliver twice the inverse performance of the S&P 500 Index, so if that index were to correct by 5%, then theoretically you could get a 10% gain via SDS. While the prospects of this kind of gain may be tempting, remember that inverse ETFs can be quite volatile. If you’re going to use them, make sure you have a stop-loss in place to protect yourself if things don’t go your way.
3) ProShares Short MSCI Emerging Markets
Even before the latest selling in stocks caught fire, emerging markets were already burning. One of the darling sectors of the market in past years, so far 2011 has seen a retreat from emerging markets. Taking advantage of a continued slide in this sector is easy with the ProShares Short MSCI Emerging Markets (NYSE:EUM). This short ETF is up over 6% year to date. By comparison, the ProShares Short S&P 500 is down 3.4% on the year, and that’s despite a 2% rise in that fund just this week. This performance divergence between emerging markets and domestic markets is a trend that’s firmly in place—and that’s a trend traders can profit from via EUM.
4) Direxion Small Cap Bear 3X Shares
The small-cap segment of the market is usually volatile when compared to its mid- and large-cap brethren. That’s true on both the upside, as well as the downside. Lately, the downside trend is here in small caps, and that means big profit opportunities in the Direxion Small Cap Bear 3X Shares (NYSE:TZA). This fund is designed with aggressive traders in mind, as it employs leverage toward its goal of delivering three times the inverse performance of the small-cap Russell 2000 Index. If you’re firmly bearish on small caps, then TZA is great way to put your money where your conviction is.
5) ProShares UltraShort DJ-UBS Crude Oil
The final short ETF on our list just might turn out to be the biggest winner of them all as oil prices have down lately and continue to slide. It’s the ProShares UltraShort DJ-UBS Crude Oil (NYSE:SCO). This fund is a two-beta leveraged bet against rising crude oil prices. So, if oil prices were to fall 4%, then SCO would likely surge 8%. This is clearly a play on the continued settling price of crude.
Higher oil production and weakness in economies around the world that are now burning less gasoline and other fuels have helped push down crude prices 14 percent in the last month and 25 percent from a high in February. Reports in recent days of weak job growth in the U.S., a deepening financial crisis in Spain and slowing growth in China have rattled markets.
It is this kind of sector volatility that could provide big gains in this short oil ETF.