After historic crashes like Thursday’s, the last thing many investors want to do is buy stocks. They’ve just ridden a roller coaster from Hell, and their tolerance for risk has fallen alongside their precious portfolios. But there’s no denying equities are more attractive after a 10% plunge than before. Today’s gallery offers up three limited-risk trades to buy while there’s blood in the streets.
Deploying bullish trades when the world seems to be ending is the definition of being a contrarian. And while it’s not the easiest position to take, it can be lucrative if you get the timing right and have the guts to pull the trigger. Proper position sizing (assuming the right amount of risk) is the key to ultimate success. But this is true with all types of bets!
The options market gives traders much more control than stocks in a situation like this. Rather than buying shares that carry open-ended exposure, you can structure a low-cost spread trade with only a few hundred bucks (or less) of risk.
Here are three limited-risk ways to play for a market rebound.
I’ve mentioned before that stock picking loses its appeal during crashes. Stocks across the board move together. Rather than splitting hairs on whether it’s better to buy tech stocks or industrials, financials or healthcare, we’re going to buy the entire market.
The first and most obvious choice is to use the S&P 500 ETF (NYSEARCA:SPY). As of Thursday’s close, it had fallen 25% from its peak, driving it deep into bear country. Oversold readings are off the charts, and the speed of the drop is making 2008 look like a walk in the park. And as someone who traded through the ’08 meltdown, that’s a sentence that I never thought I’d ever type.
My favorite limited-risk trade for banking on a bounce-back in the SPY is to buy out-of-the-money bull call spreads. I’ll elaborate on its appeal with my next pick.
As far as pricing goes, with the insane overnight gaps, it’s anyone’s guess as to where we open on any given day. That makes it difficult to put down a price that I know you’ll have the ability to get filled at. Discretion is warranted if prices change dramatically from the suggested cost.
The Trade: Buy the SPY JUN $280/$290 bull call spread for around $4.
Traders preferring a tech-weighted tilt to their broad market bounce-back bet could use the PowerShares QQQ Trust (NYSEARCA:QQQ). My read on both of them is similar, so allow me to instead expand on the bull call spread angle.
First off, by using June options, we’re giving stocks three months to work through their issues and recover. That provides flexibility with the management. If we get a rapid snap-back in the next two weeks and you want to take profits, then do so. But you also have the bandwidth to let it ride if you want a bigger profit or if the market takes longer to pull itself out of the abyss.
You can adjust the strikes higher or lower to modify the price paid until it fits your taste. Going higher reduces cost while increasing the potential reward. But, it will lower the probability of profit. Lowering the strikes used has the opposite effect.
The Trade: Buy the QQQ JUN $205/$215 bull call for around $2.90.
If you’re looking to go global with your contrarian play, then the Emerging Markets ETF (NYSEARCA:EEM) is worth a look. In addition to providing exposure to Asia, Latin America and Europe, it’s also a great deal cheaper than SPY and QQQ. At yesterday’s lows, EEM had fallen 29% off its January highs, which places it almost right in line with the damage suffered by the S&P 500.
One of the reasons we’re using call spreads over long calls is because of the high implied volatility. With the CBOE Volatility Index (CBOEINDEX:VIX) touching 76 yesterday, premiums have become incredibly expensive. Selling a call against the one you are buying mitigates the cost.
The Trade: Buy the JUN $38/$42 bull call spread for around $1.
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