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With the stock market falling for the next few weeks, or even months, it’s time to rehash how to profit from falling markets one more time. There is nothing worse than closing the barn door after the horses have bolted. No doubt, you will receive a wealth of short selling and hedging ideas from your other research sources and the media at the next market bottom. That is always how it seems to play out. So I am going to get you out ahead of the curve, putting you through a refresher course on how to best trade falling markets now, while stock markets are still only 3% short of an all time high, and unchanged on the year. Market’s could be down 10% by the time this is all over. That is my line in the sand! There is nothing worse than fumbling around in the dark looking for the matches after a storm has knocked the power out. I’m not saying that you should sell short the market right here. But there will come a time when you will need to do so. So here are the best ways to profit from declining stock prices, broken down by security type: Bear ETFs Of course the granddaddy of them all is the ProShares Short S&P 500 Fund (NYSEARCA: SH ), a non-leveraged bear ETF that is supposed to match the fall in the S&P 500 point for point on the downside (see prospectus ). Hence, a 10% decline in the (NYSEARCA: SPY ) is supposed to generate a 10% gain the in the SH. In actual practice, it doesn’t work out like that. The ETF has to pay management operating fees and expenses, which can be substantial. After all, nobody works for free. There is also the “cost of carry,” whereby owners have to pay the price for borrowing and selling short shares. They are also liable for paying the quarterly dividends for the shares they have borrowed, around 2% a year. And then you have to pay the commissions and spread for buying the ETF. Still, individuals can protect themselves from downside exposure in their core portfolios through buying against it. Short-selling is not cheap, but it’s better than watching your gains of the last seven years go up in smoke. Virtually all equity indexes now have bear ETFs. Some of the favorites include the PSQ , a short play on the NASDAQ (see prospectus ), and the DOG , which profits from a plunging Dow average (see prospectus ). My favorite is the RWM , a short play on the Russell 2000, which falls 1.5X faster than the big cap indexes in bear markets (see prospectus ). Leveraged Bear ETFs My favorite is the ProShares Ultra Short S&P 500 (NYSEARCA: SDS ), a 2X leveraged ETF ( prospectus ). A 10% decline in the generates a 20% profit, maybe. Keep in mind that by shorting double the market, you are liable for double the cost of shorting, which can total 5% a year or more. This shows up over time in the tracking error against the underlying index. Therefore, you should date, not marry, this ETF or you might be disappointed. 3X Leveraged Bear ETFs The 3X bear ETFs, like the UltraPro Short S&P 500 (NYSEARCA: SPXU ), are to be avoided like the plague ( prospectus ). First, you have to be pretty good to cover the 8% cost of carry embedded in this fund. They also reset the amount of index they are short at the end of each day, creating an enormous tracking error. Eventually, they all go to zero, and have to be periodically redenominated to keep from doing so. Dealing spreads can be very wide, further added to costs. Yes, I know the charts can be tempting. Leave these for the professional hedge fund intra day traders they are meant for. Buying Put Options For a small amount of capital, you can buy a ton of downside protection. For example, the April $182 puts I bought for $4,872 allowed me to sell short $145,600 worth of large cap stocks at $182 (8 X 100 X $6.09). Go for distant maturities out several months to minimize time decay and damp down daily price volatility. Your market timing better be good with these, because when the market goes against you, put options can go poof, and disappear pretty quickly. That’s why you read this newsletter. Selling Call Options One of the lowest risk ways to coin it in a market heading south is to engage in “buy writes”. This involves selling short call options against stock you already own, but may not want to sell for tax or other reasons. If the market goes sideways, or falls, and the options expire worthless, then the average cost of your shares is effectively lowered. If the shares rise substantially they get called away, but at a higher price, so you make more money. Then you just buy them back on the next dip. It is a win-win-win. I’ll give you a concrete example. Let’s say you own 100 shares of Apple (NASDAQ: AAPL ), which closed on Friday at $95.13, worth $9,513. If you sell short 1 July, 2016 $100 call at $1.30 against them, you take in $130 in premium income ($1.30 X 100 because one call option contract is exercisable into 100 shares). If Apple close2 below $100 on the July 15, 2016 expiration date, the options expire worthless and you keep your stock and the premium. You are then free to repeat the strategy for the following month. If closes anywhere above $100 and your shares get called away, you still make money on the trade. Selling Futures This is what the pros do, as futures contracts trade on countless exchanges around the world for every conceivable stock index or commodity. It is easy to hedge out all of the risk for an entire portfolio of shares by simply selling short futures contracts for a stock index. For example, let’s say you have a portfolio of predominantly large cap stocks worth $100,000. If you sell short 1 June, 2016 contract for the S&P 500 against it, you will eliminate most of the potential losses for your portfolio in a falling market. The margin requirement for one contract is only $5,000. However if you are short the futures and the market rises, then you have a big problem, and the losses can prove ruinous. But most individuals are not set up to trade futures. The educational, financial, and disclosure requirements are beyond mom and pop investing for their retirement fund. Most 401ks and IRAs don’t permit the inclusion of futures contracts. Only 25% of the readers of this letter trade the futures market. Regulators do whatever they can to keep the uninitiated and untrained away from this instrument. That said, get the futures markets right, and it is the quickest way to make a fortune, if your market direction is correct. Buying Volatility Volatility (VIX) is a mathematical construct derived from how much the S&P 500 moves over the next 30 days. You can gain exposure to it through buying the iPath S&P 500 VIX Short Term Futures ETN (NYSEARCA: VXX ), or buying call and put options on the VIX itself. If markets fall, volatility rises, and if markets rise, then volatility falls. You can therefore protect a stock portfolio from losses through buying the VIX. My latest on the VIX is available here . Selling Short IPOs Another way to make money in a down market is to sell short recent initial public offerings. These tend to go down much faster than the main market. That’s because many are held by hot hands, known as “flippers,” and don’t have a broad institutional shareholder base. Many of the recent ones don’t make money and are based on an, as yet, unproven business model. These are the ones that take the biggest hits. Individual IPO stocks can be tough to follow to sell short. But one ETF has done the heavy lifting for you. This is the Renaissance IPO ETF (see prospectus ). Buying Momentum This is another mathematical creation based on the number of rising days over falling days. Rising markets bring increasing momentum, while falling markets produce falling momentum. So selling short momentum produces additional protection during the early stages of a bear market. BlackRock has issued a tailor made ETF to capture just this kind of move through its iShares MSCI Momentum Factor ETF (NYSEARCA: MTUM ) ( prospectus ). Buying Beta Beta, or the magnitude of share price movements, also declines in down markets. So selling short beta provides yet another form of indirect insurance. The PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA: SPHB ) is another niche product that captures this relationship. The Index is compiled, maintained and calculated by Standard & Poor’s and consists of the 100 stocks from the SPX with the highest sensitivity to market movements, or beta, over the past 12 months. The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November. (See prospectus .) Buying Bearish Hedge Funds Another subsector that does well in plunging markets are publicly listed bearish hedge funds. There are a couple of these that are publicly listed and have already started to move. One is the Advisor Shares Active Bear ETF (NYSEARCA: HDGE ) ( prospectus ). Keep in mind that this is an actively managed fund, not an index or mathematical relationship, so the volatility could be large. Oops, Forgot to Hedge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Inside JPMorgan U.S. Mid Cap ETF
The broader U.S. market has been in a tight spot since the beginning of 2016 due to a host of global issues and uncertainty about the rate hike. Amid these concerns, mid-cap funds offer the best of both worlds, growth and stability when compared to small-cap and large-cap counterparts. Mid-cap funds are believed to provide higher returns than their large-cap counterparts, while witnessing a lower level of volatility than small-cap ones. Given the swings in the broader market segment so far this year, mid-cap funds have garnered a lot of attention as they are not very susceptible to volatility (read: 5 Mid Cap Value ETFs Are Top Picks Now–Here is Why ). Recently, one of the renowned ETF issuers, JPMorgan, introduced a product in the U.S. targeting the mid-cap space. The new product – JPMorgan Diversified Return U.S. Mid Cap Equity ETF (NYSEARCA: JPME ) – hit the market on May 11. Below, we highlight the product in detail: JPME in Focus The fund seeks to track the performance of the Russell Midcap Diversified Factor Index. JPME does not seek to outperform the underlying index nor does it seek temporary defensive positions when markets decline or appear overvalued. Its sole intention is to replicate the constituent securities of the underlying index as closely as possible. JPME is a well-diversified fund, where Westar Energy Inc. (NYSE: WR ) takes the top spot with 0.61% weight. Other stocks in the fund have less than 0.60% exposure individually. In total, the fund holds about 602 stocks. Sector-wise, Consumer Goods gets the highest exposure with 15.5% of the portfolio. Utilities, Financials, Consumer Services, Health Care, Industrials and Technology also get double-digit exposure in the basket. The fund has an expense ratio of 0.34%. How Does it Fit in a Portfolio? The fund is a good choice for investors seeking high return potential that comes with lower risk than their small-cap counterparts. With the tone of the minutes from the April FOMC meeting, released last week, being more hawkish than expected, chances of a rate hike in the June meeting have gone up. This could be due to a series of recently released upbeat U.S. economic data (read more: Fed to Hike in June? Expected ETF Moves ). Meanwhile, global growth worries are still at large. So, mid-cap stocks with higher exposure to the U.S. markets than their large-cap counterparts look attractive at this point. Thus, the launch of the new ETF targeting the U.S. mid-cap market seems well timed. ETF Competition The newly launched ETF will have to face competition from mid cap-focused ETFs like the iShares Core S&P Mid-Cap ETF (NYSEARCA: IJH ) . IJH is one of the most popular ETFs in the space with an asset base of $26.3 billion and average trading volume of 1.3 million shares. The fund tracks the S&P MidCap 400 index and charges 12 basis points as fees which is much lower than the aforementioned product. The SPDR S&P MidCap 400 ETF (NYSEARCA: MDY ) is another popular fund in the space with an asset base of $15.3 billion and trades in a good volume of more than 2.1 million shares a day. The fund tracks the S&P MidCap 400 Index. The fund charges 25 basis points as fees. Apart from these, JPME could also face competition from the iShares Russell Mid-Cap ETF (NYSEARCA: IWR ) tracking the Russell MidCap Index. The fund has an asset base of $12 billion and volume of almost 359,000 shares a day. It has an expense ratio of 20 bps. Thus, the newly launched fund is costlier than the popular ETFs in the space. So, the path ahead can be challenging for JPME. Link to the original post on Zacks.com