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5 ETF Options Trades to Play the Market Recovery

Three bullish and two bearish ETF option strategies to play

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5 ETF option plays for a market recoveryThe market has spent the last three months flashing signs that a recovery may indeed be underway, though you wouldn’t know it from the daily trading volume. It still appears that retail investors have yet to engage the market. From our perspective, the market is still flashing signs that our year-end target of 1,500 for the S&P 500 is still well within the realm of possible outcomes.

The market’s first-quarter uptrend was fueled by fairly consistent signs of improvement in our domestic economy. At the same time, rhetoric surrounding the Eurozone and Greece died down to a level that was less distracting from the domestic economy for the bulls. The result of this environment was a powerful improvement to the technical picture for stocks as the market’s trend has once again become investor’s friend.

The positive fundamental and technical picture has been met with serious doubts from investors, creating a powerful “Wall of Worry” for stocks to climb.

Last week’s employment data — a figure that came in at about half of the expected 200,000 jobs created — was the first disappointment thrown the market’s direction in some time. The news is almost certain to get some bulls in the selling mood as they lock in some of their lofty year-to-date gains.

That said, the pullback may better be described as a buying opportunity for those that have been stuck on the sidelines waiting for an opportunity. Well, the current stall in the major indices may be just the opportunity that sidelined bulls have been waiting to pounce on, meaning we could be looking at the next buying opportunity for stocks.

With all of this in mind, let’s take a look at a few of our favorite sectors to lead the market higher through 2012 and a few options positions to help you leverage that strength.

Trade #1: XRT

Retail activity is the lifeblood of our economy, so it shouldn’t be a big surprise to you when you hear this is one of the perennial leadership sectors when the market starts a long-term rebound. According to our research, the SPDR S&P Retail ETF (NYSE:XRT) typically rallies almost two times as strong as the S&P 500 out of intermediate-term bottoms when a recovery rally is underway. Our research suggests the XRT may finish 2012 around $73.

Based on the expected performance, the average investor might consider a position in the XRT as an “alpha generator” for their portfolio as the retail sector is likely to lead the market higher through 2012. For those investors that are looking to leverage the Retail sector’s leadership, let’s consider a few options.

For those looking to add some leverage to their portfolio, the XRT January 2013 65 call, priced at about $3.10, offers a long-term conservative options strategy. At its current level, you’re risking $310 per contract with potential for an option that would have an intrinsic value of $800 per contract if our target price is right. The position would net a return of more than 150% with those assumptions.

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