What Is an Inverse ETF and Its Benefits

An inverse ETF is a type of exchange-traded fund that allows you to profit from a market decline. It does this by using derivatives to bet against the market, essentially shorting it.

Inverse ETFs can be a useful tool for investors who want to hedge against potential losses or capitalize on a downturn. They can be used to reduce the risk of a portfolio or to make a contrarian bet on a market that's expected to decline.

One of the key benefits of inverse ETFs is their ability to provide a high degree of liquidity, making it easy to buy and sell them quickly. This is because they're traded on major exchanges, just like stocks.

Inverse ETFs can be a useful tool for traders who want to profit from or hedge against declines in a specific market. They work best in the short term and are best used as a short-term hedge or to make a directional bet on the market.

Curious to learn more? Check out: Best Etfs for 401k

Inverse ETFs can be used to speculate on downward moves, such as if you believe the Fed will announce an unexpected monetary policy that will send markets down. You can buy an inverse ETF around that meeting, but be aware that this is pure speculation and not advised.

Using inverse ETFs in your portfolio is an advanced strategy, and it's essential to know when to enter and exit a position in an inverse ETF because they can move against you very quickly.

Inverse ETFs can be leveraged, which means they can amplify your returns, but also means that volatility loss could play a significant role in your overall results. This is why it's crucial to keep the holding period to a minimum.

Here are some examples of inverse ETFs that you might consider using:

Remember, inverse ETFs can be a powerful tool, but they require careful consideration and a solid understanding of how they work.

Inverse ETFs are a type of fund that seeks to deliver a return that is the opposite of the daily performance of a specific index or benchmark. They can track broad-market indexes, specific sectors, or other types of benchmarks, and are similar to shorting a stock in that you are betting against a particular investment.

Inverse ETFs use daily futures contracts to produce their returns, which allows investors to make a bet that the market will decline. If the market falls, the inverse ETF rises by roughly the same percentage minus fees and commissions from the broker.

Here are some key benefits and risks of inverse ETFs:

However, inverse ETFs can also lead to losses quickly if investors bet wrong on the market's direction, and higher fees exist with inverse ETFs versus traditional ETFs.

Inverse ETFs use financial derivatives like futures, swaps, and options contracts to take short positions in the underlying index. These derivatives allow investors to bet on the direction of a security's price.

Suggestion: Etfs Derivatives

A futures contract is a contract to buy or sell an asset or security at a set time and price. This contract is bought and sold daily by the fund's manager, which means there's no guarantee that the inverse ETF will match the long-term performance of the index or stocks it's tracking.

Inverse ETFs are actively managed, which means they're constantly being rebalanced to maintain the inverse relationship as markets move each trading day. This rebalancing is done daily to ensure the fund's performance is aligned with the underlying index.

Here's a breakdown of the key characteristics of inverse ETFs:

If the market falls, the inverse ETF rises by roughly the same percentage minus fees and commissions from the broker. However, if the market goes up, the fund must pay the daily return to the counterparties from its cash holdings, which can lead to losses.

Inverse ETFs come in various types, allowing investors to target specific markets or sectors.

There are inverse ETFs that focus on broad market indexes like the Russell 2000 or the Nasdaq 100.

Some inverse ETFs concentrate on specific sectors, such as financials, energy, or consumer staples.

Investors can use inverse ETFs to profit from declines in their chosen sector or market.

Inverse ETFs can also be used to hedge a portfolio against falling prices, as seen with investors who own an ETF that matches the S&P 500.

Inverse ETFs are best suited for short-term investing, particularly when used as part of a market timing strategy.

In a market with a long-term upward bias, profit-making opportunities via inverse funds are indeed limited in long time spans.

These funds might struggle to make money in a flat or rising market, which is a major consideration for investors.

Inverse ETFs are designed to rebalance daily, but this can lead to divergence from actual inverse performance over longer periods.

Inverse ETFs tend to compound losses in volatile, upward-trending markets, which can result in a decline in value over time.

This is a crucial aspect to consider, especially for investors who are looking for long-term buy-and-hold investments.

Inverse ETFs are complex products meant for active traders, not long-term investors.

You might enjoy: Pimco Etf Funds

Inverse ETFs can cause increased trading activity, which may lead to higher volatility.

Some people claim that this trading is significant, while others argue that it's not.

The three U.S. listing exchanges – the New York Stock Exchange, NASDAQ, and BATS Global Markets – have taken steps to mitigate this issue.

In 2015, they resolved to cease accepting stop-loss orders on traded securities.

See what others are reading: Trading Etfs System

Short selling is a strategy used by investors to profit from a decline in the price of a stock or security. It involves borrowing shares from a broker and selling them with the goal of buying back the shares at a lower price later.

You'll need a margin account to short sell, which can be a challenge for investors with certain types of accounts, such as IRAs.

Short selling comes with risks, including the possibility of the stock price rising instead of falling, which means you'll have to buy back the shares at a higher price than the original sale price.

Broaden your view: Proshares Short S&p 500 3x

This can lead to significant losses, and in extreme cases, your broker may issue a margin call, requiring you to add more cash to your account or cover your short sale before things get out of hand.

The cost of short selling can also be high, with stock loan fees paid to the broker for borrowing the shares, which can exceed 3% of the borrowed amount.

Here are some key differences between short selling and inverse ETFs:

Inverse ETFs are best used in the short term, making them a useful hedge on an existing position in your portfolio.

They're particularly effective when you have a directional bet on the market, such as anticipating the Fed's monetary policy announcement.

You can use an inverse ETF to cap the downside and upside of unexpected earnings results, like buying the Direxion Daily Technology Bear 3x Shares before tech stocks report earnings.

However, it's essential to keep the holding period to a minimum due to volatility loss, which can destroy your profits.

Traders buy inverse ETFs to profit from or hedge against declines in a specific market. They can also be used to speculate on downward moves.

Traders may use inverse ETFs to make a directional bet on the market, as seen in the example of buying an inverse ETF before a Fed meeting. In this case, the trader believes the Fed will announce an unexpected monetary policy that will send markets down.

Short-term traders often use inverse ETFs to hedge against declines in their existing portfolio. For instance, if you hold a lot of tech stocks that are set to report earnings, you might buy the Direxion Daily Technology Bear 3x Shares before they report.

Inverse ETFs are best used as a short-term hedge or to make a directional bet on the market. They can move against you very quickly, so it's essential to know when to enter and exit a position.

Additional reading: Etf Short Gold

Here are some key reasons traders buy inverse ETFs:

Keep in mind that using inverse ETFs is an advanced strategy, and it's crucial to understand the risks involved, including volatility loss.

Inverse ETFs are most useful as a very short-term hedge due to the high expense ratios associated with them.

Most investors will find it difficult to incorporate inverse ETFs into a solid long-term investment strategy.

The high expense ratios of inverse ETFs can eat into your returns, making it challenging to achieve your financial goals.

Investing in an ETF that tracks a broad-based market index and charges a very low expense ratio is a simple and effective strategy that can produce great results with minimal effort.

Inverse ETFs are not a reliable choice for most investors, and it's essential to do your research before considering them as part of your portfolio.

Inverse ETFs can be unpredictable and may not always behave as expected. For instance, if an investor puts $100 in an inverse ETF position in an asset worth $100, and the asset's value drops 99% to $1 the next day, the inverse asset will gain 99% to $199 on that day.

However, if the asset then climbs from $1 to $2 on the following day, the inverse ETF position would drop 100% that day, and the investment would be completely lost. This particular scenario requires both abrupt and profound volatility – by contrast, the S&P 500 index has never increased by more than 12% in one day.

Some inverse ETFs have performed well in times of market downturn, such as the BetaSharesBEAR fund, which gained 16.9% in March 2020, compared to a fall of 20.7% in the S&P/ASX 200.

Intriguing read: Sp500 Index Etf

In the real world, inverse ETFs can be a valuable tool for traders who want to bet against the market. ProShares Short S&P 500 (SH) is a prime example.

This ETF provides inverse exposure to large and midsize companies in the S&P 500. It had an expense ratio of 0.88% as of Q4 2023.

On a single day in November 2023, the S&P 500 rose 1.07%. As a result, shares of SH fell 1.07% from $14.88 to $14.72.

An inverse ETF position can increase in value even when the underlying asset decreases, due to the compounding effect of the inverse relationship. For example, if the asset's value drops from $100 to $80, the inverse ETF position will increase by 20%.

The value of the inverse ETF position will continue to increase as the asset's value decreases, but it will also decrease as the asset's value increases. In the example given, the ETF's value increased from $100 to $150 after the asset's value dropped from $100 to $60.

However, if the market swings back to $100, the net profit of the short position is zero, but the inverse ETF will lose 67% of its value, resulting in a loss of $50. This highlights the potential risks of investing in inverse ETFs.

A sharp and significant drop in the asset's value can lead to a substantial gain in the inverse ETF position, but a subsequent rapid increase in the asset's value can wipe out the gain. For instance, if the asset drops 99% to $1, the inverse ETF will gain 99%, but if the asset then increases 100% to $2, the inverse ETF position will drop 100%, resulting in a complete loss of the investment.

Here's an interesting read: Value Index Etf

In 2008, the iShares Dow Jones US Financial ETF barely moved, but its double-short counterpart, ProShares UltraShort Financials, lost 13.2% over a week.

The ProShares UltraShort Financials ETF's decline was significant, despite the underlying ETF remaining relatively flat.

Between December 1 and December 5, 2008, the iShares Dow Jones US Financial ETF dropped to a low of 37.92, a daily decrease of 15.7%.

The BetaSharesBEAR fund gained 16.9% in March 2020, outperforming a 20.7% fall in the S&P/ASX 200.

BetaShares' geared Australian short fund, BBOZ, did even better, rising 33% in March 2020, compared to a 20.7% drop in the S&P/ASX 200.

For the March quarter, BBOZ rose by 40.6%, against a 23.1% fall in the index.

The BetaShares leveraged US fund, BBUS, surged by 22.6% in March, compared to a 19.7% fall in its benchmark index, the S&P 500 Total Return Index.

For the March quarter, BBUS gained 47.8%, versus a fall of 19.7% for the index.

Additional reading: Gold Etf Asx

In the world of inverse ETFs, the list of available funds is quite extensive. There are several providers offering a range of inverse ETFs that can help investors hedge against potential losses or profit from market downturns.

AdvisorShares offers the Ranger Equity Bear, listed on the NYSE Arca as HDGE.

BetaShares Exchange-Traded Funds offers a trio of Australian Equities Bear Hedge Funds, listed on the ASX as BEAR, BBOZ, and BBUS. They also offer several other inverse ETFs, including the Boost 3X Short Gold, listed on the LSE as 3GOS.

The Boost 3X Short Gold is just one of many inverse ETFs offered by Boost. They also offer inverse ETFs for other commodities, such as silver, natural gas, copper, WTI, FTSE100, S&P 500, Nasdaq 100, Dax, and Eurostoxx50.

Direxion offers two inverse ETFs: the Financial Bear 3X, listed on the NYSE Arca as FAZ, and the Russell 2000 Bear 3x, listed on the NYSE Arca as TZA.

ProShares offers a range of inverse ETFs, including the Short Dow 30, listed on the NYSE Arca as DOG, and the Short S&P 500, listed on the NYSE Arca as SH.

Here are some of the inverse ETFs offered by various providers:

HBP offers a range of inverse ETFs, including the S&P/TSX 60 Bear Plus ETF, listed on the TSX as HXD. They also offer inverse ETFs for other Canadian and global markets, such as the S&P/TSX Capped Energy Bear Plus ETF and the S&P 500 Bear Plus ETF.

Tuttle Capital offers the Short Innovation ETF, listed on the Nasdaq as SARK.