Looking for Hedging Opportunities

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From rising oil prices to falling demand for copper, several signs point to a potential market downturn.

As the selling rolls into the market today, I am trying to look for hedging opportunities. I am a bit surprised that the Market Volatility Index (VIX) isn't a bit more elevated, but the futures roll on the S&P 500 may be partly to blame. So how do you get through this? Close your eyes and hope? Well, that usually doesn't turn out so well. I've been using the InterETF model for well over a year now, and even though there are some bumps and gyrations along the way, it does present some unique hedging opportunities. But each portfolio is unique, so I thought I would take a look at one possible pair and break it into three concepts: the hedge, the trade for profit and the combination.

The simplest starting position is looking at a pair designed to chase a profit. When the market is off sharply, as it is today, I like to look for a bullish type of pair with the Direxion Daily Small Cap Bull 3x Shares (TNA) and Direxion Daily Small Cap Bear 3x Shares (TZA) usually first on my go to list. With the volatility in the market, I want to go out as far as I can on the options chain for the two securities. I first start with my intended short position, which will be April TZA calls; therefore, I am looking at shorting TZA April 60 calls. These are 46% out of the money, but they are leveraged, so I look at the trade as being about 15% out of the money on the underlying index. I am comfortable with that amount of room on the Russell 2000 through April expiration. Therefore, I will sell these calls for $0.90 each. Given the current prices of TNA and TZA, I will sell about 1.85 calls for each TNA put I intend to purchase. In this case, I will be buying TNA April 43 puts for $0.50. Based on the current prices, if TNA and TZA move in line with each other, TNA will get to $43 before TZA reaches $60. Unfortunately, it isn't that simple, as compounding could work for this position or against it, but there is lots of room to maneuver. Providing a net credit around $1.12, there is the potential to close the trade early as time passes if these move sideways or the market moves higher. This is a bullish trade aimed at making a profit.

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