Inverse ETFs allow investors to bet against, or “short” the market. Here we’ll look at the best inverse ETFs for the S&P 500 Index for 2023 to profit from stock market downturns.
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Inverse ETFs Video
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What Is an Inverse ETF and How Do They Work?
So what is an inverse ETF?
Inverse ETFs can be a market timer’s best friend. They allow bears to short, or bet against, the stock market. That is, when stocks drop, the value of these ETFs goes up. As such, these products are also referred to as “short ETFs” or “bear ETFs.”
Typically bonds are held for downside protection due to their uncorrelation to stocks. A more direct hedge to maximize gains while the market drops is to use inverse ETFs to short the market.
Inverse ETFs use derivatives such as futures, options, and swaps to produce positive returns from market declines. Specifically, as the name suggests, these funds aim to deliver the inverse return of their target index. I’ll explain that math for each fund in a bit, but here’s a visual illustration of this concept using the performance of one of the live funds mentioned below versus the S&P 500 index for the year 2022:
Notice how the lines are mirror images of each other.
In the next section we’ll talk about why investors might want to use inverse ETFs.
Why Inverse ETFs?
Inverse ETFs allow investors to effectively short the market without using a margin account to short sell. Short selling involves borrowing a security and selling it to other traders with the hope of later buying it at a lower price to pocket the difference as profit.
When you short a stock or ETF in a margin account, theoretically the underlying security has infinite upside, so your portfolio can suffer catastrophic losses. The GameStop fiasco of 2021 is a great example of this. When using an inverse ETF, however, losses are limited only to the amount invested.
Using inverse ETFs also do not require you to have a margin account; you can buy them in your regular taxable brokerage account or even in your IRA.
Bears who use inverse ETFs usually target the S&P 500, as inverse ETFs for the index have the greatest liquidity, and the S&P 500 is considered a proxy for the broader stock market. These products have soared in popularity in 2022 and early 2023 with the U.S. stock market’s disappointing recent performance and grim outlook for the near future.
Next we’ll briefly cover the risks of inverse ETFs and things to keep in mind when using them.
Inverse ETF Risks
It’s important to consider the risks of inverse ETFs and understand that they are not for everyone.
Inverse ETFs are best used over the short term since the underlying derivatives contracts are settled daily by the fund manager, meaning they experience decay over long time periods. The greater the leverage multiple of the inverse ETF, the greater that decay.
When using inverse ETFs, especially leveraged ones, go in with a game plan, stick to it, monitor your holdings, and have an exit strategy. Also pay attention to things like fees and trading volume, as inverse ETFs typically carry much greater fees than traditional funds, and liquidity is important when entering and exiting an inverse position.
Below we’ll look at the 3 best inverse ETFs to bet against the S&P 500 Index with the greatest liquidity.
The 3 Best Inverse ETFs for the S&P 500 Index
So again, in this context we’re using inverse ETFs to short the famous S&P 500 Index, which is considered a barometer for the U.S. stock market and is sometimes colloquially referred to as “the SPX” or “the S&P” or simply “SPY,” which is actually the ticker for the most popular S&P 500 ETF.
Below are the 3 best inverse ETFs to short the S&P 500. They all come from ProShares, one of the leading providers of inverse and leveraged ETFs.
SH – ProShares Short S&P 500 ETF
SH is the ProShares Short S&P 500 ETF. It is the most popular inverse ETF, with nearly $3 billion in assets.
The fund provides a -1x daily return – direct inverse behavior – of the S&P 500 Index. For example, if the S&P 500 Index drops by $1, this ETF will rise by roughly $1.
This ETF has an expense ratio of 0.89%.
SDS – ProShares UltraShort S&P 500 ETF
Those desiring a little more volatility may want to use leveraged funds. SDS is the ProShares UltraShort S&P 500 ETF. It is a leveraged inverse ETF providing -2x daily returns of the S&P 500. If the S&P 500 drops by $1, this ETF will rise by roughly $2.
This fund has about $1 billion in assets and an expense ratio of 0.90%.
SPXU – ProShares UltraPro Short S&P 500 ETF
There’s also a -3x ETF. SPXU, the ProShares UltraPro Short S&P 500 ETF, delivers -3x daily returns of the S&P 500. If the index drops by $1, the value of this ETF will rise by roughly $3.
This ETF has nearly $1 billion in assets and an expense ratio of 0.91%.
Bears making a short-term bet on an impending crash may want to use this -3x ETF to get the most bang for your buck, since its expense ratio is only slightly higher than that of the other two funds above, but realize this could cause greater losses if your directional bet is wrong.
Where To Buy These Inverse ETFs for the S&P 500 (Not at Vanguard)
All the above inverse ETFs should be available at any major broker, though note that Vanguard does not allow the purchase of inverse or leveraged products.
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Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.
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