With equities on the ropes this week, it’s time we looked at the best bear trades to bank on for the next market drop.
The stock rebound since March has been violent. Its duration and magnitude have caught many traders by surprise, particularly those obsessing over the grim economic data. That said, trying to reconcile rising asset prices on Wall Street with the warzone on Main Street has generated more than a little cognitive dissonance.
However, spectators convinced that the chickens would eventually come home to roost are seeing their forecast play out this week. Stocks are falling anew, especially in the most economically sensitive areas like small-caps.
So, rather than try to pick which individual stocks, we’re focusing instead on playing the weakest industries. There are many to choose from, but here are three underperforming ETFs that look particularly vulnerable:
- iShares Russell 2000 Index ETF (NYSEARCA:IWM)
- SPDR S&P Banking ETF (NYSEARCA:KRE)
- SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP)
Let’s break down the charts of each, and build high reward bear trades on each.
High Reward Bear Trades: iShares Russell 2000 Index (IWM)
If you find the Nasdaq Composite ETF (NASDAQ:QQQ) index a stone’s throw from all-time highs a bit quizzical given the horror show that is the economy right now, then it’s because you’re looking at the wrong basket of stocks. While tech mega-caps have found themselves largely insulated from the nasty price action, small-caps have not; They’ve born the brunt of the damage.
From peak-to-trough, the Nasdaq Composite ETF only fell about 30%. By contrast, the Russell 2000 Index was down 41%. And though the selling pressure eased through the back half of March and all of April, the relative weakness remained. Currently, QQQ is only 7.5% off its peak, but IWM is off by 26.5%.
Moreover, the rationale for small-caps’ weak ways is simple: They’re more sensitive to economic downturns. With this week’s whack, IWM now sports a lower-swing high and lower low. Though it rallied back by day’s end, it also pushed below the 50-day moving average. Wednesday’s slide was particularly ugly, with volume swelling past 58 million shares.
If you’re willing to bet the downturn returns IWM close to March’s low over the coming two months, then here’s a trade that will deliver big returns:
The Trade: Buy the July $105/$100 bear put spread for around 90 cents.
You’re risking 90 cents to make $4.10 if IWM falls to $100.
SPDR S&P Banking ETF (KRE)
One of the industries weighing on small caps has been regional banks. The specter of a deep recession caused investors to flee KRE throughout February and March. Ultimately, the fund fell 52% from 2019’s peak before a bottom was found. But the bounce-back has been meager compared to the robust buying elsewhere.
What’s worse, this week saw KRE crack support and tumble below its 20-day and 50-day moving averages. Momentum increased during the downswing to confirm sellers have returned to power. Thursday’s session is giving bulls some hope but it’s going to take more than a single session of strength to right this hole-ridden ship.
If you think we ultimately return to March’s levels of $27, then this bear trade offers a smile-inducing payout.
The Trade: Buy the July $30/$27 bear put spread for around $1.00.
You’re risking $1 to make $3 if KRE sits below $27 at expiration.
SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
The final spot ripe for bear trades is the energy sector. Specifically, we’re focusing on the Oil & Gas ETF, XOP. It’s performed far worse than the Energy Sector ETF (NYSEARCA:XLE) in large part because it lacks the heavy weighting toward large caps that XLE does.
Crashing oil prices have done a number on all energy-related ETFs. Some companies have already declared bankruptcy, and it could be just the beginning. While it’s true that XOP has enjoyed a nice rebound off its lows, even rising north of the 50-day moving average, it remains one of the more vulnerable areas of the market. This week’s drop saw XOP break short-term support and its 20-day moving average. It’s the first support breach since the uptrend began and could spell the start of the next downswing.
Once again, we’re harnessing bear put spreads to profit.
The Trade: Buy the Sep $35/$30 put spread for $1.00
You’re risking $1 to make $4 if XOP is below $30 at expiration.
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