There are times when a bearish bet against a benchmark stock index such as the Standard and Poor's 500 Index (S&P 500), or a bet that the price will fall, can be appropriate. One way to do this is buying into an exchange-traded fund (ETF) that rises in price when the S&P 500 falls in price. These types of bearish ETFs are also known as inverse ETFs.
Compounding Effect on Holding Time
Leveraged inverse ETFs are similar to inverse ETFs, but they’re designed to offer multiple positive returns if an index declines in value. Unlike long-term ETFs, leveraged inverse ETFs are created to duplicate the inverse one-day movement of stock indexes such as the S&P 500. They also reset daily, which results in a compounding effect that can be beneficial if the S&P 500 makes consecutive day-to-day losses. However, it can cause decay if volatility causes inconsistent up-and-down days.
Because of this, investors should determine how long they plan on holding inverse ETFs and focus on a short-term trade. In general, the effects of compounding can take a negative toll if held for longer than a week in a choppy market. If the market consistently sells off, then the compounding effect can improve the performance.
ProShares Short S&P 500 ETF
The ProShares Short S&P 500 inverse ETF was formed in June 2006. The fund was developed to inversely mirror the one-day performance of the S&P 500 by a factor of negative 1X. Therefore, if the S&P 500 rises 2%, then SH should fall 2%, minus the expense ratio of 0.89%. The average daily volume of The ProShares Short S&P 500 inverse ETF was 2.65 million shares as of Sept. 28, 2018, according to ProShares.
ProShares UltraShort S&P 500 ETF
The ProShares UltraShort S&P 500 ETF was formed in July 2006. SDS trades cheaper than SH, but it delivers double the price gains and volatility. This leveraged inverse ETF was designed to mirror the one-day performance of the S&P 500 by a factor of negative 2X. That means if the S&P 500 falls 2%, SDS should rise 4%, minus the expense ratio of 0.89%. As of Sept. 28, 2018, the average daily volume of the ProShares UltraShort S&P 500 ETF was 3.07 million shares. The extra leverage tends to invite more speculators looking to get more bang for their buck.
ProShares Ultra VIX Short-Term Futures ETF
Aggressive investors and traders looking for more risk and larger price swings may consider the ProShares Ultra VIX Short-Term Futures ETF. This leveraged inverse ETF mirrors the S&P 500 Volatility Short-Term Futures Index (VIX) by a factor of 1.5X. The VIX is often considered the fear index, as it tracks the implied volatility of the S&P 500 options. Traders use this popular tool as a method of short selling the S&P 500 on a one-day time frame. UVXY tends to move inversely with the S&P 500 most of the time. The exception is during periods of contango when the futures price of a commodity is above the expected spot price. Traders will find it best to invest in this ETF during volatile market sessions where the S&P 500 trades in a price range greater than 2%. As of Sept. 28, 2018, UVXY traded an average of 11.51 million shares daily, according to ProShares, with an expense ratio of 0.95%. During periods of heavy volatility, UVXY spreads can widen to as much as 10 cents, with price percentage gains or losses of up to 4X those of the S&P 500.