How do investors and traders cope with a market that has fallen more than 40% in
just one year and survive until greener pastures return?

Many traders have lived to tell the tale by trading both the long and short sides,
or by taking a longer-term inverse (contra) exchange-traded funds (ETFs) as a portfolio hedge. And it’s the contras that have insulated them against the big slides.

These are funds that benefit from market declines and advances in price — some
approximately point-for-point and others by a factor of two. And they enable you
to have all the benefits of shorting the market without the hassles of borrowing
stock and incurring margin debt.

Even when a market segments is hit hard, individual names often trade against the
segment.

If you think oil is moving in a certain direction, do you really want to pick one
or two winners or losers, or is it smarter to play a move in the entire segment?

That’s a no-brainer. It is much smarter to play the segment. And if you want the
volatility you get with an individual stock, you can buy a call or a put.

ETFs are the purest way to mirror the movement of a market segment such as financials or oil stocks, and new ETFs are added literally every week.

Many of these ETFs have options, and the liquidity of these options is increasing
every hour.

Also, ETFs typically have nicely sloped charts that are easy to read and easy to
trade — making options trading less volatile and easier to manage.

Buying an ETF to go long (or short) a market segment means you have an opinion about that segment. So why limit yourself, and your ability to make money on this opinion to just the ETF itself?

You already buy options on stocks or the market, and more and more this activity
is migrating from your trading or play money account to your serious trading or
investment account. Why not expand your horizons to entire market segments, a much more efficient and potentially profitable approach?  
 

If you want to maximize volatility, puts and calls on ETFs are the way to go. A
3% drop in the Dow Jones Financial Index equates to a 6% gain in the ProShares UltraShort Financials ETF ( class=”getaquote”>SKF) which, in turn, would probably generate a 40%-75% gain in selected calls for that ETF.

Not bad for a 3% move in the index, far more than you would get if an individual
bank stock went down 3%.

ETFs let you play a belief, such as the price of oil is going up or down. A double-short or double-long ETF reinforces that opinion in a highly efficient manner — when
oil moves a dollar, your ETF moves $2.

So it follows that a call on a long ETF on oil means you really see oil prices going
up, and a put means you really believe they are really going down.

Options on ETFs, while quite risky, are the cheapest and most efficient way to reinforce a belief in a position in the market — and potentially the most profitable.

A call or a put on an ETF enables you to play a trend — such as the banks are falling or the banks are rising — without investigating the fundamentals or the charts of a dozen or more companies.

I don’t recommend it, but they are also a way to play a binary event like
a major headline everyone knows is coming — something that has a major impact on a market segment. And get in and out quickly and very profitably if you are right.

ETFs are a great way to play the long-term, underlying fundamentals of a market
segment.

If you think oil is going up, you can buy calls on an oil ETF or sell puts — you
won’t mind being “put” the ETF as you are convinced it is a good
long-term play.

And you can buy them months out and “roll” them into longer-term positions
as needed — tying up much less capital than purchasing an individual stock or ETF,
but generating greater profits.

Using puts and calls extends the reach of your trading account or portfolio, and
this is multiplied by an order of magnitude when using puts and calls on ETFs.

If you think three related market segments will be hit by a recession — consumer
spending, retail spending and housing, for example — there are ETFs on all three,
and you can use a relatively small part of your account to play these segments and
generate large profits compared to owning individual stocks or even options on stocks.

A rewarding (but risky) trade is buying a call on an inverse or short ETF. These
ETFs are designed to move as an index or underlying commodity moves. Given the nature of these instruments, double-inverse ETFs are best used to bank short-term gains when you want to short a market segment, even though they carry a lot of volatility and more risk than other trades.

Consider this scenario: You think three major banks — Citigroup ( href=”http://studio-5.financialcontent.com/investplace/quote?Symbol=C” class=”getaquote”>C),
Bank of America ( class=”getaquote”>BAC) and Wells Fargo ( class=”getaquote”>WFC) — are going to surprise with worse-than-expected earnings. So you buy calls on the Short Financials ProShares ( href=”http://studio-5.financialcontent.com/investplace/quote?Symbol=SEF” class=”getaquote”>SEF)
–- the short ETF for financials -– and you hang on for the ride. Although premiums
seem stiff, a 5% down move in the financials means a 5% up move on the ETF, and perhaps a 40% up move in the calls. That’s an eightfold increase in profits, thanks to the leverage provided by the call.

Before you do any of this, make sure the puts and calls on an ETF are liquid and
don’t be put off by spreads, they are wider than for most options on stocks. Use
limit orders and, well, you know the rest.