Discovering the power of inverse ETFs

Within the world of ETFs, there is a unique category that often goes unnoticed, but is essential for those seeking more complex and speculative investment strategies: inverse ETFs. These instruments are powerful tools that allow investors to profit from falling, rather than rising, prices of an underlying asset. Unlike traditional ETFs, which seek to replicate the rising performance of an index or asset, inverse ETFs are designed to generate profits when prices fall. In this article we will see what an inverse ETF is, what they are for, the differences they have from short selling, types of inverse ETFs and we will see a real case of an inverse ETF. 

What is an inverse ETF?

An inverse ETF is an exchange-traded fund (ETF) that is constructed using various derivatives to profit from the decline in value of an underlying benchmark index. Investing in inverse ETFs is similar to holding multiple short positions, which involves borrowing securities and selling them in the hopes of repurchasing them at a lower price. An inverse ETF is also known as a “short ETF” or “bearish ETF.”

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Returns of S&P 500 Futures (green) vs S&P 500 Inverse ETF (red). Source: Tradingview.

What are inverse ETFs for?

Many inverse ETFs use daily futures contracts to produce their returns. A futures contract is a contract to buy or sell an asset or security at a certain time and price. Futures allow investors to bet on the direction of a security's price. Inverse ETFs use derivatives (such as futures contracts) that allow investors to bet on the market's decline. If the market falls, the inverse ETF rises by about the same percentage, minus broker-dealer fees and commissions. Inverse ETFs are not long-term investments, as the fund manager buys and sells derivatives contracts daily. Consequently, there is no way to guarantee that the inverse ETF will match the long-term returns of the index or securities it tracks. Frequent trading often increases fund expenses, and some inverse ETFs may have expense ratios of 1% or more.

Inverse ETFs vs. Short Selling

An advantage of inverse ETFs is that they do not require the investor to maintain a margin account, as would be the case for investors who wish to take short positions. A margin account is one in which a broker lends money to an investor to trade. Margin is used with short positions, an advanced trading activity. Investors who enter short positions borrow securities they do not own so they can sell them to other traders. The goal is to buy back the asset at a lower price and unwind the trade by returning the shares to the margin lender. However, there is a risk that the value of the security will rise rather than fall and the investor will have to repurchase the security at a price higher than the original margin sale price.

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Differences between short selling and an inverse ETF. Source: Candor.co.

Types of Inverse ETFs

There are several inverse ETFs that can be used to profit from declines in broad market indices, such as the Russell 2000 or Nasdaq 100. There are also inverse ETFs that can be used to profit from declines in broad market indices, such as the Russell 2000 or the Nasdaq 100. There are also inverse ETFs that focus on specific sectors, such as financials, energy or consumer staples. Some investors use inverse ETFs to benefit from market declines, while others use them to hedge their portfolios against falling prices. For example, investors who own an ETF that matches the S&P 500 can hedge S&P declines by owning an inverse ETF for the S&P. However, hedging also has its risks. If the S&P rises, investors would have to sell their inverse ETFs, as they would be experiencing losses that would offset any gains on their original investment in the S&P. Inverse ETFs are short-term trading instruments that must be timed perfectly for investors to make money. There is a significant risk of loss if investors allocate too much money to inverse ETFs and poorly time their entries and exits.

Real example of an inverse ETF

ProShares Short S&P 500 (SH) offers inverse exposure to large and mid-sized companies in the S&P 500. It has an expense ratio of 0,5 per share. It has an expense ratio of 0,90% and more than $1.770 billion in net assets. The ETF is intended to provide a one-day trading bet and is not designed to be held for more than one day. In February 2020, the S&P went down and as a result, as of February 17, 2020, the SH rose from $23,19 to $28,22 on March 23, 2020. If investors had been in the SH During those days, they would have made profits.

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ProShares Short S&P 500 Inverse ETF daily returns for Q4 2023. Source: Proshares.


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