At Tuesday’s high, the S&P 500 had officially risen 26% off its lows. The magnitude of the rally, coupled with improving technicals, is providing plenty of evidence that the bottom could be in. Unfortunately, bear market rallies have a history of looking very convincing before the bottom falls out. To prepare for this possibility, I’ve identified three smart bear trades.
Stock picking remains a challenge due to market correlations running hot. Furthermore, as we’ve seen just this week, sometimes the weakest stocks rally the strongest as shorts get squeezed, and bargain hunters finally pounce. Retail, restaurants, airlines and casinos found themselves among Tuesday’s biggest gainers.
So rather than run the risk that we deploy a bear trade on the one or two tickers that don’t drop like everything else, we’re using the following ETFs:
- SPDR S&P 500 ETF Trust (NYSEARCA:SPY)
- iShares Russell 2000 Index (NYSEARCA:IWM)
- Energy Select Sector SPDR (NYSEARCA:XLE)
If you’re willing to bet the recent market rebound is a ruse and stocks will begin falling afresh, then these trades are for you.
Smart Bear Trades: SPDR S&P 500 ETF Trust (SPY)
While it’s true that the short-term trend for the S&P 500 has turned higher, piling in at these prices is ill-advised. The risk versus reward simply isn’t favorable. Buying now wagers not only that the bear market low is in, but also that we could see a relatively smooth path to higher prices.
That said, I find the second piece just too hard to swallow. On the technical front, there are multiple overhead resistance zones, including the declining 50-day and 200-day moving averages. A rocky earnings season is on the horizon, and we’ve yet to see the full effects of the novel coronavirus on economic data. Downside surprises could result in future stock selloffs.
Throw it all together, and entering limited risk bear trades seems wise.
The Trade: Buy the June $240/$220 put vertical spread for around $4.00.
iShares Russell 2000 Index (IWM)
Small caps present an even more attractive opportunity. IWM tracks the Russell 2000 Index and provides broad-based exposure to a diversified basket of companies with market capitalizations in the “small-cap” range. While SPY has seen its daily trend turn higher, IWM has not.
It came close, though! Tuesday’s strong open saw the fund attempt a push through $118 resistance, but the breakout bid ultimately failed. The weaker balance sheet of small-caps has seen them punished far worse than their bigger brethren. From peak-to-trough, IWM fell 44% versus only 36% for SPY.
One of the biggest appeals for using the likes of SPY and IWM for our bear trades is liquidity. High volatility has widened bid-ask spreads and increased the amount of slippage suffered by traders. But since SPY and IWM are two of the most actively-traded funds on the planet, their options offer the best liquidity available.
The Trade: Buy the June $100/$90 put vertical spreads for around $2.15.
Energy Select Sector SPDR (XLE)
The next logical place for me to go was energy. Its tie with oil gives it far more distinction from the S&P 500 than most other sectors. Said another way, there’s less redundancy between going bearish on SPY and energy than if we played a sector like financials or industrials.
Last week’s oil surge boosted XLE and energy stocks across the board. The fund gapped over short-term resistance, pushing well above its 20-day moving average. Like SPY, XLE has succeeded in turning its short-term trend higher, but the long-term view is still bearish. If you believe we could see another push lower before all is said and done, then this rebound is offering an attractive entry point.
The Trade: Buy the June $30/$25 put vertical spread for around $1.30.
For a free trial to the best trading community on the planet and Tyler’s current home, click here! As of this writing, Tyler Craig held bullish positions in IWM.