Trading the S&P 500 bear market using ETFs

On Friday, May 20th, the S&P 500 Index (SPX) briefly dipped into the bear market territory, defined as a 20% or more drawdown from a recent high point. In this case, the SPX briefly plunged to 3,810, down significantly from its 52-week high of 4,818. This was led by recent losses in the retail sector, dragged down by poor earnings reports from both Walmart (WMT) and Target (TGT). 

However, the increased volatility still offers investors and traders of all dispositions a chance to make decent returns. There is a vast selection of ETFs out there that can be used to trade the index for bullish or bearish, long-term, or short-term oriented investors alike. Today, I'll be highlighting six ways to navigate the S&P 500 bear market, along with six ETFs I selected via the Trackinsight ETF screener that complement each strategy. 

Low-cost buy-and-hold

Investors bullish on the large-cap stocks of the S&P 500 over the long term could minimize their fees using the Vanguard S&P 500 ETF (VOO). Warren Buffett recommended this fund for his wife's estate, and for a good reason. For a very tiny expense ratio of 0.03%, investors access the top 500 U.S. listed large and mid-cap stocks. The index is extremely difficult to beat over the long run and is regarded as a benchmark for professional fund managers to compete against. VOO is the ETF version of the world’s first index mutual fund, the Vanguard 500 Index Investor (VFINX) and has attracted high AUM and investor interest since its inception. 

Options trading

Covered calls, cash secured puts, LEAPS, iron condors, box spreads – options traders looking to profit off the high volatility of the S&P 500 usually opt for the larger, more liquid SPDR S&P 500 ETF (SPY). As the most liquid ETF in the world, SPY has a well-developed options chain, which allows traders to get the best order execution. Although slightly more expensive than VOO with a 0.09% expense ratio, SPY has a much lower bid-ask spread, which is beneficial for traders. The fund has been around for quite a long time now and has attracted billions in AUM. Little known fact – SPY was the first ETF in existence!

Going long with leverage

Ultra-bullish investors banking on another quick V-shaped S&P 500 recovery often employ leverage to enhance their returns. While some use margin, others may use leveraged ETFs like the ProShares UltraPro for a short-term trading instrument. UPRO offers 3x daily reset leverage to the returns of the S&P 500. The key word here is “daily.” If held for more extended periods, UPRO returns might be highly unpredictable due to how volatility decay and compounding affects returns. The fund also has a high expense ratio of 0.95%. 

Going short with leverage

Conversely, investors feeling bearish about the S&P 500's short-term prospects tend to take short positions, either using margin or put options. An alternative is using the inverse of UPRO, which would be the Direxion Daily S&P 500 Bear 3x Shares (SPXS). This fund offers 3x daily inverse exposure to the S&P 500. Like UPRO, SPXS poses many of the same risks and is not suitable as a long-term holding as indicated in the fund’s prospectus. Like UPRO, SPXS also has a high expense ratio of 0.95%. The fund also reverse splits frequently to maintain its share price. 

Selling covered calls

The current high-volatility, side-ways trading market conditions have significantly boosted the viability of a covered call strategy. Yield-hungry and income-oriented investors have increasingly turned to covered calls as bond prices plummeted and dividend stocks lost value. While investors can buy 100 shares of an ETF like SPY to sell calls on, this approach is cost-prohibitive for those with smaller account sizes. Another way to implement a covered call strategy is through the Global X S&P 500 Covered Call ETF (XYLD). XYLD writes out-of-the-money (OTM) options on the S&P 500, pocketing a handsome premium for doing so. As of date, the 12-month trailing yield of the ETF stands at 11.81%. 

Implementing a collar

While covered calls can bring in significant income from the premiums, they do not protect the downside. If the underlying stocks or ETFs fall, investors are fully exposed to those losses. The use of a collar options strategy can mitigate that. ETFs like the Global X S&P 500 Collar 95-110 ETF (XCLR) sell 10% OTM calls and use a portion of that premium to buy 5% protective put options. This limits both downside risk and upside return and reduces volatility. This makes XCLR a possible defensive hold during bear markets. XCLR currently has a 12-month trailing yield of 8.56% and an expense ratio of 0.60%. 

Disclaimer: This article is limited to the dissemination of general information pertaining to investment strategies and financial planning and does not constitute an offer to issue or sell, or a solicitation of an offer to subscribe, buy, or acquire an interest in, any securities, financial instruments or other services, nor does it constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment.