It was the kind of day that inverse and leveraged exchange traded funds (ETFs) were seemingly made for. As the markets plummeted, inverse and leveraged funds soared by as much as 18%.
Bear funds ruled the day today, underscoring the benefits of such funds on days where the markets are feeling down. Among the biggest gainers were:
- Direxion Daily Real Estate Bear 3x (NYSEArca: DRV)
- Direxion Financial Bear 3x (NYSEArca: FAZ)
- ProShares UltraShort MSCI Brazil (NYSEArca: BZQ)
- ProShares UltraShort Real Estate (NYSEArca: SRS)
Leveraged and inverse ETFs have several useful applications for investors who don’t mind taking on some extra risk. You can use them to hedge short-term moves in the market. If you had done so today, would would have done well. DRV, for example, was up by more than 18% at one point.
The caveat with leveraged and inverse funds, however, is that they’re designed to hedge daily market moves. On a day-to-day basis, these funds work exactly as they should. But once the market closes, all leveraged and inverse ETFs will reset and start over tomorrow. [Our Guide to Leveraged and Inverse ETFs.]
Multiply these daily moves and resetting over a period of days or weeks, and you’ll witness the impact of compounding. This means that if you’re holding such an ETF for a period longer than a day, it won’t track its underlying benchmark 1:1. The effect is heightened in volatile markets, which is what we’re in right now.
If you’re worried about more losses in the markets and you’re not shy about risk, leveraged and inverse ETFs can be a useful addition to your portfolio.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.