With so much attention being paid to the looming fiscal cliff, investors are starting to look for ways to trade depending on the outcome. We have already taken a look at four companies that are likely to pay special dividends by the end of the year, and today we will look at a few trades you could consider if you believe Congress and President Obama won't reach a deal.
While it is possible that Congress and the president will come together to avoid the fiscal cliff, it will not be easy. The last few years we have seen Congress very divided along party lines, and they have not been able to work together very well. If Republicans and Democrats are unable to overcome their differences, we will go over the fiscal cliff. The following trades are possible ways to profit from a trip over the Fiscal Cliff.
1.) iShares S&P National Municipal Bond ETF (MUB)
The part of the fiscal cliff that worries most investors is the possibility of higher capital gains tax. The Bush-era tax cuts put a ceiling of 15% on capital gains, but this tax cut is scheduled to expire, and we could see the tax on capital gains rise back to the 20% level that was in effect under President Clinton. Municipal bonds will start to look more attractive to investors because their yields are tax free at the federal level. MUB is a diversified national municipal bond ETF, so it has a low risk of default and is the most popular municipal ETF.
MUB is up 7.5% in 2012. Look at the February 110/105 bull put credit spread for a credit of 30 cents. If capital gains do revert to 20%, we expect to see strength in municipals, but even if we do not, this trade still has about 3% downside protection with a target return of 6.4%.
2.) Consumer Staples Select Sector SPDR (XLP)
Historically, the consumer staples sector has been a good way for investors to protect their assets. The reason is simple, no matter what happens with the U.S. economy next year, people are still going to have to purchase household staples. Obviously no sector is safe in the event of a complete economic meltdown, and this ETF is vulnerable to consumer spending trends, but overall it is a fairly defensive play you can consider to avoid the impact of the fiscal cliff.
XLP is up 12.5% in 2012. Look at the March 34/30 bull put credit spread. You will be selling the March 34 puts, while buying the same number of March 30 puts for a credit of 30 cents. This trade has 5.2% downside protection with a target return of 8.1%.