If market volatility spikes back up and markets sell-off again, investors may consider hedging the potential risks through geared exchange traded funds that track leveraged and inverse strategies.
On the recent webcast, ETF Trading Strategies for Volatile Markets, Mike Eschmann, Managing Director and Co-Head of Capital Markets & Institutional Strategy Team for Direxion Investments, helped explain how investors may magnify and hedge returns on a daily basis with leveraged and inverse strategies. For instance, a bull funds may seek 3x or 300% the daily performance of a benchmark, whereas a bear fund may seek -3x or 300% of the inverse of the daily performance of a benchmark.
Additionally, due to compounding, the leveraged and inverse ETFs may diverge from their long-term intended strategies. A strong bull market without long interruptions and relative lack of volatility can help maintain positive gains in the leveraged ETF. Since the ETFs rebalance on a daily basis, the compounding effect benefits leveraged ETFs in a upward-trending market. However, in times of increased volatility, leveraged ETF returns can fall behind their intended 2x or 3x strategies.
Eschmann pointed to four factors that are contributing to current volatility in the marketplace: the Chinese A-Shares market, oil swings and its effect on the energy sector, a potential Federal Reserve rate hike ahead and ongoing concerns in Europe, notably from Russia and Greece.
For instance, during the Crimea and Ukraine hostilities, investors played the Russia trade through the Direxion Daily Russia Bear 3x Shares (NYSEArca: RUSS) to hedge the downside and the Direxion Daily Russia Bull 3x Shares (NYSEArca: RUSL) to capture a potential bounce when things settled. [As Bears Leave Russia ETF, Some get Bullish With Leverage]