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3 Bear Trades to Bet on the Dead-Cat Bounce

  • Friday’s stock surge is likely another in a long line of failed market rallies. Here are three easy bear trades to bet on a dead-cat bounce.
  • iShares Russell 2000 ETF (IWM): Small-caps consistently underperform in bear markets, and this fund is 27% off its highs.
  • Invesco QQQ Trust (QQQ): The rotation out of growth stocks continues to weigh heavily on the technology sector.
  • Ark Innovation Fund (ARKK): Suffering one of the largest falls from grace in history.
A photo of stock prices on a digital screen with a city street reflected in the glass and visible in the left side of the image.
Source: katjen/ShutterStock.com

Bulls are celebrating Friday’s nearly 4% gain in the Nasdaq. It’s a rare victory after a string of defeats and deserves some fanfare. But while recency bias may have buyers in a good mood, I fear this rebound could fail like every other one this year. It may be a sucker’s rally designed to lure in complacent bulls only to murder them during the next downturn. Rather than fall prey to the dead-cat bounce, I have three bear trades that will profit from it.

The fact that stocks were up big doesn’t automatically signal a bottom. Recall that the largest rallies always occur in downtrends. It’s a byproduct of the sky-high volatility accompanying bear markets. This year’s descent has been littered with promising-looking ascents that ultimately gave way to gravity.

Due to the high correlation between stocks, I elected to pitch three ETFs to keep things simple.

Ticker ETF Price
IWM iShares Russell 2000 $178.50
QQQ Invesco QQQ $299.82
ARKK Ark Innovation $42.67

Bear Trades: iShares Russell 2000 ETF (IWM)

iShares Russell 2000 ETF (IWM) with potential dead-cat bounce.
Source: The thinkorswim® platform from TD Ameritrade

Recession fears disproportionately affect smaller companies. They lack the bigger balance sheets and institutional adoption that many of their larger brethren boast. In short, they are riskier and thus more likely to be abandoned in times of turmoil. To wit: the iShares Russell 2000 ETF (NYSEARCA:IWM), which is the most popular small-cap ETF available, is 27% off its highs. By comparison, the S&P 500 is only down 18%.

With continued uncertainty swirling around the Street, IWM will likely continue to underperform. And that makes it a top choice for bear trades if you think this bounce fails. So far, we’ve only risen for two trading sessions. An ideal retracement would carry us higher for another few days to the declining 20-day moving average. Regardless of how many days we climb, I like using a previous day’s lows as the trigger for bear trades.

While any bearish options strategy works, I’m going with a bear call spread to capture a high probability of profit. My rule is to increase the likelihood of profit as much as possible while still receiving a 10% return on investment. The net credit will likely change by the time the stock triggers.

The Trade: Sell the June $195/$200 call vertical spread for at least 50 cents.

Invesco QQQ Trust Series 1 (QQQ)

Invesco QQQ Trust (QQQ) stock chart with counter-trend rally.
Source: The thinkorswim® platform from TD Ameritrade

One of the unique traits of the ongoing bear market has been the aggressive rotation out of growth stocks and into value. It’s a movement driven by three interconnected factors: inflation, interest rates, and multiple compression. Growth stocks trounced value over the past decade, causing the Invesco QQQ Trust (NASDAQ:QQQ) and the tech stocks that it holds to trade with a relatively high P/E ratio. With inflation surging and interest rising to combat it, the stocks trading with the richest multiples have fallen the most.

What’s more, Nasdaq’s generals like Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) cracked major support zones last week. The loss in leadership is concerning and means there’s now even more overhead resistance that will threaten the current bounce.

For these reasons, entering bear trades on QQQ is an intelligent way to bank on this rally failing. Once again, I like the bear call spread route. Like IWM, wait for prices to break a prior day’s low to signal the next downswing is beginning. This may not happen on Monday.

The Trade: Sell the June 332/337 bear call for at least 65 cents.

Bear Trades: Ark Innovation ETF (ARKK)

Arkk Innovation Fund (ARKK) stock chart with steep downtrend a dead-cat bounce.
Source: The thinkorswim® platform from TD Ameritrade

Perhaps no other ETF has been more emblematic of the utter destruction in high-multiple growth stocks than the Ark Innovation ETF (NYSEARCA:ARKK). At last week’s lows, ARKK was 78% off its highs, placing it within a few whiskers of its pandemic low from 2020. It is mind-boggling that prices are back to where they were when the world shut down, and economic growth fell off a cliff.

The volume crescendo accompanying last week’s drop and pop was record-breaking, with over 316 million shares traded. Optimists will argue it signaled capitulation and the bottom. If you agree with them, then don’t take this trade. Alternatively, if you think this is yet another bounce to be sold, then here’s how to capitalize.

The Trade: Buy the June $40/$35 bear put for around $1.40.

On the date of publication, Tyler Craig was long IWM. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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Article printed from InvestorPlace Media, https://investorplace.com/2022/05/3-bear-trades-to-bet-on-the-dead-cat-bounce/.

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