Is This The Rebound? A Financials Volatility Play

Over the past several weeks, I was able to enjoy an 80% return on the Leveraged 3X short Financials ETF (FAZ). As my trading account was becoming too top-heavy (short-heavy really), I sold into strength as the ETF rocketed over $100 per share as rumors of nationalization were rampant and the Dow (^DJI) hit levels not seen since 1996. I didn’t sell out completely though and still hold shares which are now moving in the opposite direction. However, this weekend, I tweeted about the potential for banking shares to double given the upcoming House Financial Services meeting which may bode well if Mark to Market accounting rules are altered. So, Monday I changed my game plan.

Was This a Bottom?

I don’t know. What I do know is that Financials will continue to see massive volatility in the coming weeks. With this in mind, rather than trying to guess which way they go from here, I entered into a volatility play.

Since I already captured substantial gains on FAZ over the past few weeks and was still holding shares, I had entered into a hedged position, buttressing those FAZ (remember, triple short Financials) with call options on FAS for April Strike at 4. FAS (FAS) is the 3X Long Financials ETF.

The thinking is that if Financials reverse course again and investors head for the exits, my FAZ shares rocket back to a 100+% gain and options expire worthless. If there’s more good news like Citi’s (C) this week and Bank of America’s (BAC) today, followed by a recommendation from the House Financial Services Committee that benefits the financials (the meeting was today, but it was unclear what the actual verdict was from what I caught), then FAS options could continue to spike.

Basically, if Financials rally enough, the loss on FAZ becomes inconsequential as the leverage from the FAS call options takes over. At the money, options tend to move about 50 cents on the dollar (delta). As of today, the gains on options have overtaken the losses on FAZ shares, so I’m on the positive side of the fence. If we move further in this direction, I can close out the options, take the profit and hope for a swing back down to double dip (and remain hedged for my net long portfolio).

Alternative Investment Plays

Other considerations for alternative investment trades include going short Treasuries on a recovery play (the short Treasury play has performed quite well this year) or if you think the impending recovery spells massive inflation due to our profligate spending to try to fix the problems from the past decade, buying gold via SPDR Gold ETF (GLD) is an option, just avoid the gold ETN GOE - even though it’s up over 400% this year, as evidenced here, there’s something rotten there, including massive spreads, irrational price movement/volatility and the fact that Credit Suisse (CS) is deleting it.

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