Alternative ETFs to Hedge Against Weakness in the Financial Sector

The financial sector is widely expected to suffer extended damage from the coronavirus fallout, and this earnings season will provide a glimpse of the devastation. Exchange traded fund investors, though, can turn to alternative strategies to hedge against further risks in this market segment.

The Financial Select Sector SPDR (NYSEArca: XLF), the largest financial services-related ETF, dipped 0.2% Tuesday after J.P. Morgan Chase and Wells Fargo both braced for severe losses on loans to borrowers hurt by the coronavirus.

According to the International Monetary Fund, the novel coronavirus outbreak exposed “cracks” in the global financial system and “will likely” see banks suffer both credit losses and market losses that will test their reserve, Reuters reports.

“This crisis presents a very serious threat to the stability of the global financial system,” the IMF said in its Global Financial Stability Report.

“Today, of course, we are in a very adverse economic scenario … we do expect that most banks and most banking systems are going to be stable,” Tobias Adrian, the director of the IMF’s monetary and capital markets department, told Reuters. “There might be some additional struggles in some banking systems and for some banks around the world.”

The coronavirus outbreak has also put 16 million Americans out of work and erased trillions of dollars of global equity markets.

“The declines in asset prices are expected to lead to losses on banks’ portfolios of risky securities, though this could be partly offset by gains on their holdings of safe-haven assets,” the IMF added.

U.S. banks are already prepping for the worse. J.P. Morgan Chase on Tuesday said it would put aside $6.8 billion to cover potential losses on loans to consumers and companies while Wells Fargo set aside $3.83 billion.

Investors who are wary of further trouble in the financial sector may also look to inverse or bearish ETFs to hedge risk. Aggressive traders may look to leveraged inverse options like the Direxion Daily Financial Bear 3X Shares (NYSEArca: FAZ)ProShares UltraPro Short Financials (NYSEArca: FINZ) and Direxion Daily Regional Banks 3x Bear Shares (NYSEArca: WDRW).

Less aggressive traders can use the ProShares Short Financials ETF (NYSEArca: SEF), which takes the single inverse or -100% of financial stocks, and the ProShares UltraShort Financials (NYSEArca: SKF), which takes a leveraged -200% of financials.

For more information on the financial sector, visit our financial category.