Make Lemonade Out of Fiscal Cliff Lemons

Traders are a predictable lot, and I think I know how they'll react to the fiscal cliff - make sure you profit from what's coming

   

I’m sick of the fiscal cliff because the sound bites leaking out of Washington have been driving trading for weeks now. In fact, ever since the uncertainty over the outcome of the presidential election was settled, traders have focused on the self-made “crisis” we’ve all come to know and hate.

Indeed, the failure to come to an agreement on the budget to avoid automatic tax hikes and federal spending cuts (primarily on defense) that would slice an estimated $600 billion out of GDP next year is something that Congress and the president brought on themselves. Remember the debt ceiling debate a little over a year ago? Well, the cliff is the result of silly stop-gap measures put in place back then by the same actors, on the same stage.

What a tragicomedy.

As of this writing, we have little more than 12 hours before the official turning of 2013, and before we technically fall off the fiscal cliff. Right now, talks on a deal to avoid a cliff dive still are far from the agreement stage. However, one thing you can be sure of is that even if we technically go over the fiscal cliff, politicians on both sides are going to come back together and put some type of stop-gap measure on things just to make themselves look good.

When this happens, we could see some buying in the markets as a sort of relief rally. That rally, if it happens, is likely to be short-lived. In fact, the more logical scenario, in my view, is that traders will do what they most often do in these circumstances, and that is to sell the news.

This selling after the uncertainty passes happened right after the election was decided, and I think it will happen again after the uncertainty over the cliff subsides. This sell-the-news situation means opportunity for aggressive, short-term traders looking to make the cliff resolution (whatever it may be) a profitable event. If stocks do sell-off after the cliff deal is announced, then a great way to ride a short-term sell-off is via a leveraged exchange-traded fund (ETF) that moves twice the inverse of its respective underlying indexes.

QID 12 31 12 Make Lemonade Out of Fiscal Cliff Lemons

The one ETF I like most here is the ProShares UltraShort QQQ (NYSE:QID), a fund designed to deliver twice the inverse of the NASDAQ 100. This is the index that holds all the large-cap tech stocks such as Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG). This fund saw a big spike after the post-election uncertainty was erased, and I suspect we could see the same kind of selling in the market – and therefore surge in QID – immediately after the cliff issue is erased.

I think that smart traders can take advantage of a sell-the-news event after a cliff deal, and a great way to do so is with QID. I would be a buyer of this fund shortly after a deal is announced, so wait until then before taking a position. Then, set a stop-loss on your QID buy around 10% below your buy point to mitigate your downside. If we see another spike higher in QID of the kind we saw after the election, then this fund should be good for about a 10%-15% pop in just a couple of weeks.

Now that is how to make lemonade out of the lemons we get from Washington.

At the time of publication, Jim Woods did not hold a position in any of the stocks mentioned here.


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