A smarter way to use leveraged ETFs

Double and triple leveraged ETFs were constructed to serve mainly as short-term trading vehicles. The reason behind is that they reflect the daily change in the underlying index (or basket of stocks).

Let assume that a triple bullish ETFs is promoted at the market with a starting price of $100. If the price of the underlying index goes up 10% for the day, the price of our leveraged beast will rise to 130 (3 x 10% x $100). If, on the very next day, the price of the underlying index drops 10%, the triple levered ETF should drop by 30% x 130 and to trade at 91 by the end of the day. The net result from those two trading days is 1% drop for the underlying index and 9% drop for the triple levered one. It is a simple mathematical rule. 10% drop in a price is recovered by 11.11% rise and 10% rise in price is erased by 9.09 drop. The levered ETFs are computed in a way that you might greatly benefit by this mathematical rule during certain market conditions.

November 2008 was the birthday month of triple leveraged ETFs. Two of the first were TZA and TNA, which were supposed to reflect 3 times the daily change in Russel 2000. They were both promoted at a price around $60 per share. Let assume that you were aware of the above mentioned mathematical rule and decided to short 50,000 worth of TZA and 50,000 worth of TNA in order to hedge your position. The net results is that you are short 834 shares of TZA and short 834 shares of TNA. Three and a half months later, the triple bearish TZA is traded at $56 and the triple bullish TNA is traded at 25. You decide to cover your short positions and in TZA you make $4 per share or $3,336 for the position; in TNA you make $35 per share or $29,190 for the whole position. The net result is $ 32,526 gain or 32.52% for 3.5 months. For the same period Russel 2000 is down about 16%.

This strategy provides best results and is safer to be used in range-bound markets, since more often retracements to a moving average will have higher depreciating effect on both levered ETFs. During periods of strong trending markets, the strategy could be detrimental for your portfolio if you don’t have percentage stops in place. Nothing goes straight up or down, but there are always exclusions and you should consider them in your risk management models. Chose levered ETFs that are well diversified, representing various sectors.

Options and Earnings


Options could be very useful tools for your trading arsenal during the highly volatile times of earnings’ season. They offer various combinations for more precise risk and performance management.

Selling a strangle (two OTM options)

Let take for example CME, which reports tomorrow, before market open. It is currently trading for $ 166.14. You look at its option chain and notice that: FEB 150 PUT is trading for $5.80 and FEB 180 CALL is trading for $6.80. You figure out that their earnings’ report won’t cause a significant stock’s move in neither direction. Then, you decide to benefit from the elevated implied volatility before the announcement by collecting premium from selling the above mentioned out-of-the-money contracts. The net result: a premium of 12.60 (1260 for the strangle) in your pocket.
– you keep the entire premium if CME closes in the 150-180 range at option expiration, which in this case is FEB 20;
– the position is profitable in the 137.40 – 192.60 range, since the received 12.60 premium upfront will offset a possible appreaciation in the put option if CME dives (break-even at 137.40 – brokers’ commisions) and it will offset possible appreaciation of the call option if CME jumps up (break-even at 192.60 – broker’s commisions);
– the downside of this strategy is unlimited and losses starts below 137.40 and above 192.60;

Selling a credit spread

Let say you are bearish on CME, but you don’t want to short the stock in front of an earnings’ event that might move it 20 points overnight in either direction. You don’t want to buy a put option of the stock, because premiums before such major announcement are highly elevated. An alternative approach for your bearishness is to use a bear call spread. In our CME example, you might buy FEB 175 CALL for 8.50 and sell FEB 160 CALL for 15.50. The net result is $7.00 in your pocket.
– your maximum gain could be $7.00 (or 700 for the spread) if CME closes below 160 at options’ expiration (FEB 20), because in such case both options will expire worthless and you will keep the credit;
– your maximum loss is $8.00 (or 800 for the spread) if CME closes above 175 at expiration, since at 175 your long call (FEB 175) will be worthless and your short call (FEB 160) will costs $15.00 per share;
– Break-even is at $167;

Call Ratio Backspread

Let say that you expect CME’s earnings report tomorrow to cause a significant move in the stock. You don’t want to buy a strangle or call and to pay premium before earnings and you have bullish expectations. In this case you might sell FEB 160 CALL for $15.50 and use the proceeds to buy 2 out-of-the-money calls. For example you might purchase two FEB 175 CALLS for 8.60 each or a total of 17.20. The net result will be a money outflow of $1.70 (17.2 – 15.5).
– maximum gain is unlimited and starts above 191.70; At 190, the short call cost 30, but the two long calls cost 15.00 each and from 190 + 1.70 up, the long position will appreciate much faster than the short, resulting in a net gain.
– maximum loss is 16.70. If CME closes at 175 at options’ expiration, your short call position will cost $15.00 and your long calls will be worthless;
– if CME dives on earnings and closes below 160 at options’ expiration, all calls will be worthless and your loss will be limited to the paid premium difference of 1.70 per share (or 170 for the whole spread);

There are many other way to utilize options for hedging and speculation and I might talk about them in another post.

Best performing stoks YTD

ANDS  +205.73%

PALM  +140%

STEM  +119%

AERN  +85.7%

NG  +81%

MEA  +88.7%

RBCN  +77.5%

GENR  +74.5%

NTCT  +71%

VNR  +68.6%

MFLX  +60%

EROC +57%

WOLF  +55%

STKL  +52.9%

CPY  +52.8%

*stocks of companies that have received acquisition bids are omitted.

I often take a look at the list of the best performing stocks year to date. Early in the year, the list is full of stocks that have bounced from the drain. Such type of stocks rarely stay long on the list and generally provide good shorting opportunities as they approach previous zones of strong resistance. As the year rolls, new leaders emerge and eventually some of them will be the best performing stocks for the year. It is useful to set up a minimum liquidity requirement (at least 100k average traded volume per day) and also minimum price requirement to isolate penny stocks. (I use $2.00 as a minimum price since too high price requirement will cut the majority of the best performing stocks for the year at their initial stage of price appreciation).

Given the current market environment, I prefer to trade, not to invest in the stocks that appear on this list as I use trailing stop to follow momentum. How to recognize which stocks from the list could be good short and which – good long ideas? Take a look below the surface. What is driving the price of the stock?  It is all about expectation and/or speculation for strong earnings in the future. Those expectations are usually based on an exciting new product, recent history of strong earnings and sales growth, industry relative strength, legislative change. These are usually good long candidates. Severely beaten down stocks that try to bounce from the ground after serious decline, usually provide good short opportunities as they approach their 200 day moving average and meet strong resistance there.

From a technical perspective, you would be in better position if limit your long ideas to stocks that make higher low and higher high above their 200 day MA as you will enter on higher high and trail with a stop to protect profits and limit downside. Short ideas should come from stocks that are finding strong resistance just below their 200 day MA and are reversing back from there after making lower high. Everything should be looked in the perspective of the general market. When the market is going up, I concentrate on long candidates and vice versa.

The best performing stocks YTD is a very simple system for generation of trading ideas and it could be a basis for huge returns if proper money management rules are applied. There is a profound difference between good long and short trading idea and successful long or short actual trade. For the latter you need strict money management rules, which include, but are not limited to: proper position sizing, cutting losses short and letting winners run.

Alternative momentum screens for the above mentioned idea generation method could be:

Stocks up 50% or more in a month

Stocks up 200% or more from their 52 week low

Stocks at 50 day highs

Again, don’t forget to add liquidity and minimum price requirement filters.