Inverse ETFs Are a Bear's Best Friend

Henry Truc |

Bear Inverse ETFsOn Wall Street, there are bulls and there are bears. If you're a bear, you're looking to make money when a stock falls. You can do that by short selling the stock. But what if you want to invest against the performance of an entire sector or industry or even the general broader equities market? One way you can do that is to short the corresponding exchange-traded fund that represents that target of assets. But, an easier investment strategy would be to use inverse ETFs.

Inverse ETFs work like regular ETFs, only their price performance corresponds with the opposite of the daily performance of the targeted assets. So, say you think the S&P 500 is headed lower. You have two options to profit from this using ETFs. First is to short ETFs that track the S&P 500 like the SPDR S&P 500 (NYSE: SPY) or the leveraged ProShares Ultra S&P500 (SSO), which is designed to produce twice the daily performance of the index. But another way investors or traders can profit from the stock index moving lower is to buy ETFs like the ProShares Short S&P 500 (NYSE: SH) or the ProShares UltraShort S&P 500 (NYSE: SDS). These types of ETFs move up in value as their target assets--in this case, the S&P 500--decline in value.

Types of Inverse ETFs

But, like other ETFs, inverse funds aren't limited to just the broader market. In fact, with the growth in popularity of ETFs in the investment community, more and more financial companies have developed new trading vehicles that capture their targeted sectors. It isn't even necessarily limited to just stock sectors and industries. One of the more popular inverse ETFs by trading volume right now is the ProShares UltraShort 20+ Year Treasury (TBT), which corresponds to twice the opposite of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond index.

Investors that are looking at inverse ETFs also have to be careful not to confuse an inverse ETF with a leveraged inverse ETF. Leveraged ETFs add an additional layer for traders to incorporate into their strategies, and it isn't uncommon for an inverse ETF to also be leveraged. Proshares has a lot of UltraShort ETFs that perform as a 2x multiplier of the inverse of its target investments. Direxion, which really specializes in leveraged ETFs, has the Bull 3x ETFs that produce three-folds the inverse of its target assets.

ETFs for Bear Investors

For bears looking to play a certain sector of the stock market or other type of asset class, here are a few ETFs that allow you to trade short positions in the area of choice.

  • Price of Oil:
    • Traders thinking that oil is going lower can look at ProShares UltraShort Oil & Gas (NYSE: DUG) or the Direxion Daily Energy Bear 3X Shares (NYSE: ERY).
  • Small Cap Stocks:
    • The ProShares UltraShort Russell 2000 (NYSE: TWM), ProShares Short Russell 2000 (NYSE: RWM) and the Direxion Daily Small Cap Bear 3X Shares (NYSE: TZA) are also good ways to bet against stocks in the Russell 2000.
  • Financials:
    • During the banking crisis in 2008, inverse ETFs that followed financial stocks were very popular. ProShares UltraShort Financials (NYSE: SKF) and Direxion Daily Financial Bear 3X Shares (NYSE: FAZ) are two examples.
  • Emerging Markets:
    • Not as excited about the growth prospects of up-and-coming economies as the rest of the market? Then ETFs like ProShares Short MSCI Emerging Markets (EUM), ProShares UltraShort MSCI Emerging Markets (NYSE: EEV) and Direxion Daily Emrg Mkts Bull 3X Shares (NYSE: EDC)

These are just a few examples of the wide variety of inverse ETFs available to investors and traders on the market. There are also ones that cover specific countries, other sectors like health care and technology, and more. But it is important to understand that while ETFs are a great way to play an overall sector of investments or asset classes, they aren't designed for long-term performance. So long-term investors planning to use these funds as a hedging strategy in their portfolios need to remember that these aren't necessarily buy and hold instruments. ETFs, especially passively managed ones, may require more careful monitoring from investors holding them.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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