Don't Forget to Hedge with Inverse ETFs in a Down Market

When investors get news that Dow Jones Industrial Average futures or other major indexes plummeted overnight, it’s good to know they have tools in their back pocket in the event markets do go awry at the opening of a new trading session. One of those tools investors can leverage, literally, is inverse exchange-traded funds (ETFs).

“These tools may be used when seeking to hedge the market,” noted Direxion Investments on their website. “As their name reveals, inverse ETFs go up when the market goes down, and they go down when the market goes up. Inverse ETFs allow you to seek the opposite return of specific sectors and asset classes; for instance, the S&P 500, and Financials, Energy and Technology sectors,” noted a Direxion.”

“Again, the thing to remember about these funds is that they’ll lose value as long as the market keeps going up,” Direxion added. “But the potential rewards can be attractive if the market suffers a setback. At the very least, inverse ETFs may serve as a hedge. It’s important to note that an -1x ETF which seeks 100% of the inverse performance of an index, is subject to daily compounding. However, basic math dictates that the compounding would be less than the compounding in a -2x or -3x leveraged ETF.”

With the ability to only go long, investors are limiting their abilities. It’s like a car with the ability to only drive forward–might make sense if you’re going in a loop, but with intersections, parking lots, pedestrians, and other hazards to watch out for, it’s nice to be able to go into reverse.

The same can be said when trading equities. When a sharp market downturn occurs, investors can hedge losses by taking the reverse direction of the markets.

“Used appropriately, even a small allocation of your capital could help make up for any losses you sustain in a market crash,” Direxion stated. “And of course, individuals should consult a financial professional before engaging in hedging activity.”

The way the S&P 500 has been behaving below can certainly make the case for inverse ETFs:

^SPX Chart

^SPX data by YCharts

An Inverse ETF Option for the S&P 500

The coronavirus could continue to put a bearish spin on major indexes like the S&P 500. As such, traders can look to the Direxion Daily S&P 500 Bear 3X ETF (NYSEArca: SPXS) for a leveraged inverse play.

SPXS seeks daily investment results equal to 300 percent of the inverse of the daily performance of the S&P 500 Index. The fund, under normal circumstances, invests in swap agreements, futures contracts, short positions or other financial instruments that, in combination, provide inverse (opposite) or short leveraged exposure to the index equal to at least 80 percent of the fund’s net assets (plus borrowing for investment purposes).

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