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ETF Periscope: Slick Trade for a Sideways Market

Posted on the 18 April 2011 by Phil's Stock World @philstockworld

“After a certain point, money is meaningless. It ceases to be the goal. The game is what counts.” — Aristotle Onassis

ETF Periscope: Slick Trade for a Sideways Market
Blame it on Libya.

Since February 22, when Moammar Gadhafi swore that he’d fight the pro-democracy rebel uprising to his “last drop of blood,” the equity market took a sharp right turn off its preceding six-month-long upward trend and began its current two-month path on the road to sideways.

Up to that point, you could say, to paraphrase Will Rogers, “the markets never met any news that it didn’t like.”  At least that’s how it acted, based on its relentless push up the right side of the graph during that time frame.

Specifically, the session prior to that tumultuous weekend found the benchmark S&P 500 Index (SPX) sitting at 1,343. As of close of market last Friday? It ended at 1,319. That’s a relatively small difference of 24 points over two months time.

The Dow Jones Industrial Average (DJIA)? Back then, it sat at 12,391. Friday’s close left it at 12,341. Fifty points difference. On the Dow. Two months later.

Like I said, sideways.

True, there were the shockwaves that crashed through the markets in tandem with the horrific natural disasters that struck Japan a little over a month ago. However, even that sad turn of events was mostly shrugged off by Wall Street, apparently absorbed into its bottom line within the breathtakingly short period of a matter of weeks.  

It’s worth noting that the S&P 500 Index is struggling to stay above its 50-day moving average. If it finds this level difficult to sustain, it wouldn’t take a whole lot before it retested the psychologically important 1,300 mark, currently just a short drop below its 50-day MA. If it starts to probe that point, things could get a little shaky.

So now here’s the new earnings season, and one has to wonder if sideways will continue to be the name of the game, or whether things are ready to shift. And if a shift is imminent, then the next question to ask is, “Into which gear?”

Last week’s first wave of earnings felt pretty weak, especially with Google getting bashed to the downside to the tune of over 8%, a six- month low. Taken together with the limp unemployment report released on Thursday, with numbers at its highest levels since mid-February, it might be enough to give the Bulls pause. That is, at least until the next wave of earnings are announced.

Both Apple and Intel are on tap to announce earnings this week. If either or both of these companies disappoint, it is possible the tech sector could take a major hit. At the least, it might force investors and analysts alike to give a deeper look at the possible impact that the Japan disaster might have on the global economy. Don’t forget, Japan is a “double-threat,” in that it is both a major supplier of components for the tech sector while also serving as a large consumer of that industry’s finished goods. While the Japanese government gave out some early damage assessments of around 300 billion dollars, that number could be dwarfed by the global economic impact that could result from any major shift that occurs in Japan’s role as supplier and consumer.

Though the markets, by nature, can always turn on a dime, there seems to be a particularly high number of current factors, such as Japan, the Middle East, the European Union debt crisis, etc, that could shake the markets out of their current complacency.

Yes, the markets seem strangely complacent.

How complacent? Well, the VIX (Chicago Board Options Exchange Market Volatility Index) closed last Friday at $15.32, putting it at a 46-month low. The VIX is commonly referred to as the fear index, as it is, by its very nature, hyper-responsive to the moods of the markets. When it is low, it means that implied volatility is down. When it goes up, it means volatility levels are up.

Under the current conditions, it might not be a bad idea to take advantage of the current VIX levels. If the markets gain some traction and start to Bull up again, the VIX likely won’t fall a whole lot more, not with all the possible bumps in the road. If the markets move downwards, the VIX will likely bounce back quickly and, depending on the cause of the down move, bounce back with a vengeance. At the very least, it makes for a good hedge to a Bullish portfolio.

One play that is worth considering is pairing a long VIX play with a short on the oil market. Oil, of course, has been above the $100 per barrel mark since the recent upheaval in Libya began, and has bounced around between 105 and 113 the last four weeks. If things get a bit calmer in the region and speculators get tired of goosing the oil futures, then oil could slide down, though probably not below the century mark, at least not for the short-term. If this happens, your short bet would pay off, and the VIX would likely fall, though again, probably not a whole lot. On the other hand, if another shock to the region hits, oil would go up. You’d lose on your short, but make up for it on the long VIX.

If you want to play this pair using ETFs, that is doable. Just substitute VXX (iPath S&P 500 VIX Short-Term Futures ETN) for the VIX, and USO (United States Oil Fund) for crude. If you prefer not to short your ETFs, then substitute an option play. Buy calls on VXX and buy puts on USO. Slightly out-of-the-money options, and a couple of months out, time-wise.

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

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