We head into the month of June, as we often do, with the market flashing signs that seasonal weakness is approaching. The signs that Wall Street is setting up for a short-term sell-off or market correction have been growing for weeks now.
- The S&P 500 continues to run into trouble trying to hold levels above the 2,120 level, which has grown to become significant chart resistance since February.
- The CBO S&P 500 Volatility Index recently hit a low reading of 12, signaling that complacency is reaching dangerous levels. It is often the case that the market experiences high levels of complacency as market tops are forming.
- The weekly Investor’s Intelligence poll remains bullishly biased, another example of the complacency that the market is experiencing. Currently, the ratio of bulls to bears stands at 3.26 and is on the rise. This ratio has been elevated for most of 2015, indicating that the “crowd” has remained a little too optimistic despite the tepid market conditions.
The combination of the market’s inability to break to new highs and the fact that investors appear to be gazing through rose-colored glasses suggests that we are likely to see a market correction sometime during the month of June.
Just because the market needs a healthy correction doesn’t mean that your portfolio needs to suffer as a result. We often hear the term “hedge” and think that “only the pros can hedge their portfolios.” That’s false.
There are a number of ways that the individual investor can hedge or profit from the upcoming market correction. Let’s look at four options:
Trades for a Market Correction: Inverse, or Bearish, Exchange Traded Funds
Click to Enlarge The ETF world has done a lot to empower individual investors over the last decade, including the introduction of some offers some great alternatives for investors that are looking to hedge their portfolios from potentially weak markets.
Inverse ETFs like the ProShares Short S&P500 (NYSEARCA:SH) allow investors to profit from a market correction. These shares will appreciate roughly 1% for every drop of 1% in the S&P 500, making them an easy way to hedge a portfolio against declines.
Trades for a Market Correction: Cash in With a Leveraged Short ETF
Click to Enlarge Just like the ProShares Short S&P500 ETF allows you to hedge a decline in the S&P, the Proshares Ultrashort S&P500 ETF (NYSEARCA:SDS) appreciates when the S&P 500 falls, only it does it at a rate of 2-to-1.
This means that every 1% decline in the S&P 500 results in a 2% increase in the value of the SDS shares. This is a more aggressive approach to hedging a portfolio, though it also carries better potential for upside.
Trades for a Market Correction: Hedge Volatility Like a Pro!
Click to Enlarge As mentioned, the VIX, also known as the “fear index,” is coming off of its lowest readings of the year, suggesting that we will see a rise in market volatility over the next few weeks.
The iPath S&P 500 VIX Short-Term Futures ETN (TSE:VXX) gives you an easy way to hedge market volatility like a pro. VXX shares go up as the VIX rises, offering an alternative hedge when market volatility shoots higher.
Our forecasts suggest a target of 16 or higher in June, which is more than 16% higher than the latest close — not a bad alternative.
Trades for a Market Correction: Always Check Your Options
Click to Enlarge Low VIX readings suggest that option premiums are cheap. This means that “insuring” your portfolio with options is inexpensive. When looking to protect a portfolio with options, it often is wise to keep it as simple as possible.
For that reason, we like the SPDR S&P 500 ETF (NYSEARCA:SPY) Jul $212 put. This option recently traded at $425 per contract. Given our current short-term target of $204 for the SPY, this option has the potential to appreciate to more than $375 during the month of June — an 80%-plus return based on current prices.
This, of course, is the most aggressive approach for those willing to speculate around a potential September market correction.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.