(RWM) Archives

It now appears that the ?Alibaba? correction (BABA) is at hand.

I warned you, pleaded with you, and begged you about this yesterday, and on May 8 (click here for ?Will Alibaba Blow Up the Market?).

The longer the company postponed the mother of all IPO?s, the higher the prices flew, until we finally got a print at the absolute apex of the market. Now, it?s time to pay the piper.

The development is part of a broader move out of riskier, higher beta stocks into safe, large caps that has been underway for several weeks now. Those traders who are ahead want to protect their years. Those who aren?t are screwed anyway, so don?t bother returning their phone calls.

Look no further than my favorite, Tesla (TSLA), which topped out on September 3, along with the rest of the MoMo high technology, biotechnology and Internet names.

Still love the cars, though.

The (IWM) has really been sucking hind teat all year, falling by 3% year to date compared to an 8% gain in the S&P 500.

Yesterday, the sushi really hit the fan when the 50-day moving average pierced the 200-day moving average for the first time since August, 2011. Known as a much dreaded ?death cross,? this is the technical equivalent of slitting both wrists and thrashing about in shark-invested waters, heralding more declines to come.

Let me list the reasons why this is the sector traders love to hate when markets move from ?RISK ON? to ?RISK OFF?:

*Since small companies borrow more than large companies, they are far more sensitive to rising interest rates. Guess what? Rates have been rocketing this month.

*Since small companies are more leveraged (indebted) than big ones, they are more sensitive to a slowing economy.

*Small companies don?t have the international diversification of their bigger brethren, and therefore have less of a financial cushion to fall back on.

*The (IWM) has roughly 1.5 times the volatility of the S&P 500, making a short position here fantastic downside protection for a broader based portfolio of stocks. So you get a lot of selling here, as managers try to lock in performance for fiscal years that start ending as early as October 31.

*Did I mention that the stock market is at one of its most overbought levels in history, the worst since 1928? Bearish sentiment is at only 13%, the lowest since 1987. These are more reason to sell, as if you needed any.

My readers have made tons of money over the years playing the (IWM) on the short side. It?s time for another visit to the trough. I?m not finishing my year early.

Not yet, anyway.

If you can?t trade options, then buy the Short Russell 2000 Fund ETF (RWM) as a 1X play, or the Direxion Daily Small Cap Bear 3X ETF (TZA) for a 3X trade. However, 3X ETF?s of any kind are for intra day traders only.

Time to Bail on a Burning House

This time I am going to start with the fundamental argument first, then follow up with the Trade Alert.

We are getting perilously close to a substantial pull back in global risk assets. While this has already started in commodities, the ags, oil, copper, and precious metals, we have yet to see the whites of their eyes in equities. I believe at these levels stocks are the planet?s most overvalued assets, at least on a short term trading basis. So I have begun more aggressively searching for plays that would benefit from substantial moves southward.

My personal preference is to gain downside exposure on small capitalization stocks. You can achieve this through buying put options on the Russell 2000 iShares ETF (IWM).

You have several things going for you in falling markets with this ETF. Small stocks are illiquid and therefore suffer the biggest pullback during market corrections. If Heaven forbid, double dip fears return this summer, small caps will fall the farthest and the fastest. They are most dependent on outside financing which rapidly dries up during times of economic distress.

You can see this clearly during last year?s summer swoon. The last time we thought the world was going to end, the (SPX) fell by 20% while the (IWM) plunged by 29.5%. This means that small cap stocks are likely to deliver 150% of the downside compared to big cap stocks. Making money then with shorts in the (IWM) was like shooting fish in a barrel.

You see this on the upside as well. Since the October, 2011 lows, the (SPX) leapt by 30% compared to a much more virile 38% move by (IWM). The (IWM) really does present the scenario where the smaller (or higher) they are, the harder they fall.

If you go into the options market you get this extra volatility at a discount. June at-the-money puts for the (SPY) carry an implied volatility of 15%, compared to 20% for the (IWM) puts. That means you get 50% more anticipated movement in the index for a premium of only 33%.

For those who wish to avoid options, you can buy the inverse ETF on the sector, the (RWM). But the liquidity for this instrument is a mere shadow of its upside cousin, the (IWM). You are better off shorting the (IWM) than buying the (RWM).