Hedging the Summer Swoon: ETFs to Protect Your Capital (VXX, UUP, DNO)

It feels as though another summer swoon is coming. The age old adage of trading of "sell in May and go away" feels like it is about to be proven correct once again. The last two years have seen significant sell-offs in the summer, so why should this time be different? The root causes of the previous slow-downs are still present: weakening US growth, the European debt crisis, and continued slowdowns in emerging markets. However, with US ten year yields below 1.75%, hedging equities with bonds seems to be extremely risky. So, the real question is, what are good ways for individuals to hedge out tail risk events? Here are a few ETF's that could help.

As we can see from this chart, the VXX VXX is a great hedge to stocks. As the S&P 500 rises, the VIX falls, and vice versa, and so a great way to trade an imminent sell-off is through this ETN, which is a basket of short-term VIX futures. The ETF is correlated to the SPY -.87, meaning that it is almost a perfect hedge to the index. Thus, hedging a stock position with the VXX here looks like a good trade. After all, stocks are down sharply from the highs, and so some might want to start nibbling at current levels. Doing so with a hedge such as the VXX will allow investors to feel comfortable in buying at these levels.

As the chart at the bottom of the page shows, the recent sell-off in stocks has not been small. 100 points in the S&P is a lot, however one can foresee a sequence of events in Europe that leads to stocks sliding lower. As we saw the last time risk assets fell, oil fell from about $113 to $78. Oil prices are largely dependent on global demand, as supply is rather constant. With prices sitting just above $90, there is still downside risk. Using the DNO DNO, the US short oil ETF, investors can catch this slide in prices. With continuing weakness in Europe, a slowdown in China, and stagnating US growth, its hard to see oil going much higher, so buying DNO seems reasonable.

Lastly, look a the UUP UUP, which is the Proshares bullish US dollar index ETF. Investors will flock to the safety of the dollar during a sell-off, so look at UUP as an alternative to bonds. As Europe deteriorates, the Euro will weaken, which will help the underlying index. Also, the Bank of Japan is doing everything in its power to weaken the Yen. All in all, the dollar looks set to rally, and by buying UUP, investors can catch this flight to safety move.