After a tumultuous start to the new year, investors may be looking into inverse or bearish exchange traded fund options to hedge or even capitalize off market turns. However, traders should take the time to understand how the products work.
Inverse ETFs, like stocks, trade on an exchange, but unlike traditional beta-index ETFs, inverse options are designed to return the opposite return of a benchmark over a short-term horizon, writes Casey Murphy for Investopedia.
Excluding fees and costs associated with trading ETFs, an inverse ETF provides an easy way to short sell a specific market, or profit off falling prices.
For instance, the ProShares Short S&P 500 (NYSEArca: SH) takes a simple inverse or -100% daily performance of the S&P 500 index. While the S&P 500 index was up 0.4% Friday, SH dipped 0.4%. Over the past month, SH declined 3.2% while the S&P 500 rose 3.2%. As we can see, the inverse S&P 500 ETF mimics the opposite movement of the S&P 500 index over the short term. [Correction Prep With These Inverse ETFs]
While inverse ETFs lost out when the S&P 500 strengthened over the past month, investors still utilize inverse ETF options for hedging or speculating.
When using inverse ETFs to hedge, investors should not go overboard with their allocations. Instead, the inverse ETFs should make up a small percentage of an overall long equity portfolio to help diminish any downside risks.