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Inverse ETFs are speculative short-term investments.
They are intended to be bought and sold during a single day.
Inverse ETFs are a way to benefit from drops in the market without having to short a security.
What is an inverse ETF?
An inverse ETF is a type of exchange-traded fund, or ETF, that bets against the expected daily performance of an asset or market index. During periods of volatility, day traders may use these “short” or “bear” ETFs as a way to reduce their exposure to or potentially even profit from downward market moves.
Inverse ETFs are risky and speculative investments that aim to achieve goals similar to short selling. As a result, the U.S. Securities and Exchange Commission describes inverse ETFs as “specialized products with extra risks for buy-and-hold investors.”
7 best-performing inverse ETFs of 2023
Below are seven of the best-performing inverse ETFs. Note that those performing well today may not be performing well tomorrow.
1 month return
MicroSectors U.S. Big Banks Index -3X Inverse Leveraged ETNs
Direxion Daily FTSE China Bear 3X Shares
MicroSectors Travel -3x Inverse Leveraged ETN
Direxion Daily S&P 500 High Beta Bear 3X Shares
Direxion Daily MSCI Emerging Markets Bear 3X Shares
Direxion Daily S&P Biotech Bear 3x Shares
MAX Airlines -3X Inverse Leveraged ETNs
Data is current as of market close on August 31, 2023, and is intended for informational purposes only.
How do inverse ETFs work?
ETFs are bundles of assets that aim to mirror an existing index return. Inverse ETFs seek daily performance objectives opposite that of an asset or index. To do so, they’re composed of derivatives such as options, swaps and futures.
For a simplified explanation, say the S&P 500 declines 2% in a day. The owner of an S&P 500 inverse ETF could stand to gain 2%. However, if the index were to instead grow by 2%, the investment would decline 2%.
However, an inverse ETF can also be leveraged, meaning it can seek 2x or 3x the expected performance of the index or asset it tracks. That's where things get especially risky. In this example, if the S&P 500 drops 2%, with a 3x leveraged inverse ETF, you'd theoretically make 6%. But if the index rises 2%, you'd lose 6%. Leveraging an investment compounds the risk taken.
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Risks and advantages to inverse ETFs vs. short selling
The fact that it’s relatively easier to buy inverse ETFs than it is to short a stock doesn’t mean they’re a good fit for every portfolio.
Yes, ETFs, including inverse ETFs, can be traded through a regular brokerage account. However, buying and selling an inverse ETF requires knowledge of day trading, focus and time.
Inverse ETF performance targets are calculated by the day and reset daily. So traders must offload any inverse ETFs by the end of the day or risk potentially compounding their losses. Making the wrong bet or holding it for more than one day can make inverse ETFs a costly investment.
For savvy traders, though, inverse ETFs can offer downside protection without the additional risks and high barriers to short selling. To short a stock, a trader must first access and fund a type of brokerage account called a margin account. Margin accounts require an application and approval process similar to a loan.
Then, short selling involves borrowing and selling securities with the expectation their price will fall and repurchasing them for cheap. Because short sellers must return the borrowed shares, they’ll eventually have to repurchase them. If the share price rose instead of fell, the short sellers could potentially lose a lot more than their initial investment if the share price surges.
Neither the author nor editor held positions in the aforementioned investments at the time of publication.
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