How to Bet Big on the Bounce

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Well, that was quick…

Following the worst October in seven years, the U.S. stock market has roared back with a vengeance.

After bottoming at 2,641 on October 29, the S&P 500 soared to 2,817 by the close of trading on November 7, fueled in part by the best post-midterm Election Day rally since 1982.

This means the U.S. stock market retracted more than 50% of its recent losses before most investors could catch their breath.

The Nasdaq, the S&P 500 and the Dow all reclaimed their long-term 200-day moving averages.

My favorite sentiment indicator, the CNN Fear & Greed Index, rebounded from a low of 5 to a more palatable 25.

In short, if you sold into the October panic, you’re probably already regretting it.

Like I’ve said before…

As an investor, you must focus less on the market’s mood swings and more on your personal psychology.

But as a trader, you must see such sharp market moves as an opportunity to profit from what may turn out to be a traditional year-end rally.

Today, I want to discuss two of my favorite ways to do just that.

1. A Leveraged Bet on the S&P 500

Say you expect the S&P 500 to bounce strongly between now and the end of the year.

You could just “buy the market” with the SPDR S&P 500 Trust ETF (NYSE: SPY).

If the market rises, say, 8%, you will generate an 8% gain.

But certain exchange-traded funds (ETFs) can do much better.

You could boost your returns with a leveraged ETF like the ProShares Ultra S&P 500 (NYSE: SSO). This ETF essentially doubles the returns on the S&P 500 Index. It turns an 8% gain in the S&P 500 into about 16%.

If you really want to swing for the fences, you could buy a 3x leveraged ETF like the Direxion Daily S&P 500 Bull 3X ETF (NYSE: SPXL). An 8% rise in the S&P 500 generates a return approaching 24% here.

(A word of warning: Both of these ETFs reset daily. As a result, they will underperform their “headline” returns over a longer time period.)

Still, if you want to try to shoot the lights out… like I am with my 3x leveraged bet on the Brazilian stock market in The Wall Street Journal’s stock-picking contest… then leveraged ETFs could be for you.

2. Options on the SPDR S&P 500 Trust ETF

Another way to leverage your bet is to buy options.

Truth be told, options are a lot trickier than ETFs. That’s because options are valued differently than stocks.

Factors include the underlying price of the stock or ETF, the strike price (price at which buyers of your options can sell the underlying shares), time to expiration, expected volatility, and interest rates.

The Black-Scholes formula for valuing options won the Nobel Prize in economics in 1997.

The good news is… you don’t need to understand this formula to trade options.

Just keep in mind the most challenging factor for short-term traders is that the value of an option plummets as it approaches its expiration.

So if you buy a short-term option – say, an option on the S&P 500 – that expires at the end of December, you really have to get your timing right.

Otherwise your option will expire worthless.

There is a way around this time crunch through a special kind of option – Long-Term Equity Anticipation Securities (LEAPS).

While most options expire in a matter of months, LEAPS expire in one to three years. That takes the imminent threat of time expiration out of the equation.

Put simply, you can be “wrong” in the short term but still come out “right” in the long term.

Yet LEAPS still require a lot less capital to turn a profit in a long-term price move than what you’d need to buy the underlying asset.

Now, I use both leveraged ETFs and LEAPS in my own trading. But they aren’t for the inexperienced investor.

And that’s where The Oxford Club can help…

If you want advice on investing in leveraged ETFs, keep an eye out for my upcoming ETF service, Oxford Wealth Accelerator.

Launching in early December, this service will offer both specific short-term ETF trading recommendations like the ones I mentioned above… and longer-term investment recommendations.

Good investing,

Nicholas

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