An inverse ETF is an exchange traded fund (ETF) constructed by using various derivatives to profit from a decline in the value of an underlying benchmark. Inverse ETFs allow investors to make money when the market or the underlying index declines, but without having to sell anything short.
Understanding Inverse ETFs
Many inverse ETFs utilize daily futures contracts to produce their returns
- Futures contracts are contracts to buy or sell an asset or security at a set time and price
- The use of derivatives-like futures contracts-allows investors to make a bet that the market will decline
- If the market falls, the inverse ETF rises by roughly the same percentage
Double and Triple Inverse ETFs
Leveraged ETFs are a fund that uses derivatives and debt to magnify the returns of an underlying index.
- Typically, an ETF’s price rises or falls on a one-to-one basis compared to the index it tracks.
- A leveraged inverse ETF delivers a magnified return when the market is falling.
Real-World Example of an Inverse ETF
ProShares Short S&P 500 (SH) provides inverse exposure to large and midsize companies in the Standard & Poor’s 500
Inverse ETFs vs. Short Selling
Benefit of inverse ETFs is that they do not require the investor to hold a margin account.
- Short selling requires a stock loan fee paid to a broker for borrowing the shares necessary to sell short.
- The cost of borrowing shares to short can exceed 3% of the borrowed amount.
Types of Inverse ETFs
Short-term trading instruments that must be timed perfectly for investors to make money.
- There’s a significant risk of losses if investors allocate too much money to inverse ETFs and time their entries and exits poorly
- Several inverse ETF types: Russell 2000, Nasdaq 100, and Consumer Staples
