Investors don’t have to sit idly by as a tanking equities markets weigh on their portfolios. There are a number of inverse exchange traded funds that help mitigate market turns, but investors should fully understand how the vehicles work before jumping in.
There is significant downside to trading inverse ETFs, and investors should monitor the investments and the potential costs associated with the offerings, writes Robert Weinstein for TheStreet. [The Right Leveraged ETFs, Right Now]
When markets fall, traders typically utilize options, specifically puts, to make profit. Most investors may not have a futures account set up, but inverse ETFs offer an alternative option. As a market fall, the inverse ETF would rise in value.
Nevertheless, potential investors should be aware that most inverse ETFs try to achieve the inverse daily performance of an underlying index. Due to compounding effects, the funds can deviate from their target strategy over extended periods. [What Are Leveraged ETFs?]
Moreover, these types of ETFs are not meant as a long-term, buy-and-hold, core positions. Most investors would set aside a small portion of their investment portfolio for inverse ETFs to hedge against potential dips in the market. In this sense, inverse ETFs act like another portfolio diversifier that has a low correlation, or rather inverse correlation, to the equity or fixed-income position.
For example, the Direxion Daily S&P 500 Bear 3x Shares (NYSEArca: SPXS), which takes the -300% daily performance of the S&P 500, provides an easy way for investors to short the market on any given day. However, Weinstein warns against holding the ETF for weeks or longer as the option may lose value, even if the market drops.