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Thursday, December 20, 2012 - 06:00
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Thursday, December 20, 2012 - 06:00
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Thursday, December 20, 2012 - 06:00

Pimco's Bill Gross on the Implications of Japanese Monetary Red Bull

Thursday, December 20, 2012 - 6:00am

The "fiscal cliff" has dominated the trading landscape ever since Election Day, and that issue's primacy has continued throughout this week's trading. On Monday, Dec. 17, stocks surged on news that Republican House Speaker John Boehner has softened his stance on taxing the most successful and wealthiest Americans. Reportedly, Rep. Boehner is willing to raise tax rates on individuals making more than a $1 million a year, in exchange for some concessions by President Obama on spending cuts.

Now, a lot of political pundits have read Boehner's move as the first of many concessions he's willing to make to get a deal done that avoids the automatic kicking in of spending cuts and tax increases adding up to about a $600 billion bite out of 2013 GDP. I suspect that a deal is going to get done soon, and that deal will likely be a political win for the president.

Of course, Wall Street wants a deal, because the newfound certainty on this issue is something traders would love. While I certainly understand the desire for clarity on tax policy, what I think is more important for short-term traders is that when a deal is done, traders are likely to do what they almost always do -- and that is sell the news.

This happened right after the presidential election, as traders turned from the uncertainty of who would occupy the White House to the uncertainty over the fiscal cliff. Once the fiscal cliff issue is settled, traders will likely turn to the next uncertainty. Whether that is lower corporate profits, a slowing economy in 2013, or Europe's latest debt drama is unclear, but you can bet that there are more concerns right around the corner.

I suspect that once a deal on the fiscal cliff is announced we are going to see stocks essentially make a short-term top, and that the next wave lower will be a sharp sell-off. This likely sell-off is a short-term, tradable development the same way the post-election selling was a short-term, tradable event.

So, what is the best way for traders to take advantage of this situation? I think you can do so with three leveraged exchange-traded funds (ETFs) that deliver twice the daily inverse of their respective indices. Let's take a look at each of these now.

ProShares UltraShort Dow (NYSE: DXD)
This fund is pegged to the Dow Jones Industrial Average, and it is designed to deliver twice the daily inverse of the widely followed index. So, if the Dow drops 2%, then theoretically, DXD will rise 4%.

The chart here shows this fund's spike immediately following the presidential election. Since reaching its November high, DXD has fallen back down due to cautious optimism over a fiscal cliff resolution. If the same kind of post-election selling in stocks takes place after the fiscal cliff is no longer a worry, then we are likely to see another spike higher in DXD to the tune of about 15%.

Action to Take --> Buy DXD at the market, as soon as the fiscal cliff deal is announced. Set initial stop-loss approximately 10% below your buy price. Set initial price target 15% above your buy price.

ProShares UltraShort QQQ (NYSE: QID)
This two-beta leveraged fund is pegged to the fate of the Nasdaq 100, the index that contains the largest tech companies out there, including stocks like Apple (Nasdaq: APPL).

This fund also saw a big spike post-election, and for the same reasons as DXD, we should expect QID to rally 15% or more after the fiscal cliff is resolved.

Action to Take --> Buy QID at the market, as soon as the fiscal cliff deal is announced. Set initial stop-loss approximately 10% below your buy price. Set initial price target 15% above your buy price.

ProShares UltraShort Russell 2000 (NYSE: TWM)
The final ETF to consider here for your sell-the-news fiscal cliff trade is TWM. The fund is designed to deliver twice the inverse performance of the small-cap Russell 2000 index, a key measure of the more speculative segment of the broad equity market.

Once again, a widespread sell-off on the fiscal cliff news will be an opportunity to make some quick profits riding the selling wave.

Action to Take --> Buy TWM at the market, as soon as the fiscal cliff deal is announced. Set initial stop-loss approximately 10% below your buy price. Set initial price target 15% above your buy price.

All three of these leveraged, inverse funds are, in my opinion, going to see big gains immediately following a deal on the fiscal cliff, and that's why you'll want to jump into each one as soon as the news is released.

Be careful, however, because as soon as buyers begin to come back into stocks after a post-cliff resolution sell-off, it will be time to exit these inverse funds (but not before you bank some nice profits).

This article originally appeared on TradingAuthority.com:
3 Trades to Make Immediately After a Fiscal Cliff Deal is Announced

Jim Woods does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.