Each year, analysts make bold predictions about an imminent downturn or correction in the markets. If investors believe the market is indeed due for a sizable drop, they can diversify their portfolios with investments that increase in value when stocks fall. In that respect, some exchange-traded funds (ETFs) allow investors to short a market instead of individual stocks, and these ETFs can earn tidy profits during market downturns.
A short sale involves borrowing shares from a broker, hoping the price of the stock goes down, buying back the stock at a lower price, and then returning the shares to the broker to bank the profit. When successful, the short seller is selling high, buying low. An inverse ETF, on the other hand, is a fund designed to provide short exposure to the entire market or a segment of the market.
- Shorting the market is betting that the stock market will fall.
- Investors can buy shares of inverse ETFs to get short exposure to the overall market or market segments.
- The UltraShort S&P 500 Inverse ETF is an example of a leveraged product that will increase in value on the days that the stock market moves lower.
- The risk to short sellers and inverse ETFs is that the market moves higher rather than lower.
Investors can buy shares of inverse ETFs when the market is ripe for a fall and sell them later, ideally at a higher price than what they paid for it. The process is done through a broker and is the same as buying shares of stock or any other exchange traded fund. In other words, the investor does not sell short shares of inverse ETFs to bet on a market fall. Rather, they buy the shares.
Inverse ETFs can be volatile and carry risk. For example, if a sell-off reverses and the market moves higher, short sellers might rush in to unwind their short positions (by purchasing back stock they had shorted), thus exacerbating the bull move higher, as buying begets more buying.
In addition, many inverse funds are leveraged, which amplifies potential profits and losses. If a fund says 2X bear fund, for instance, it is designed to move twice the inverse of the market or stock index. Below are examples of ETFs that profit from bearish moves in the market they cover.
The S&P 500 is an index and a measure of U.S. stock market performance. The ProShares Trust Short S&P 500 fund takes short positions designed to move opposite the index, making it a broad-based method for shorting the U.S. stock market.
- Avg. Volume: 3,700,000
- Net Assets: $1.75 billion
- Yield: 1.76%
- Expense Ratio (net): 0.89%
- Inception Date: June 19, 2006
This aggressive fund aims to earn twice as much as what the S&P 500 loses. Like the ProShares Short ETF mentioned above, the UltraShort is a bearish play on the S&P 500 Index. However, it is more volatile due to the fact that it is a leveraged ETF.
- Avg. Volume: 4,841,685
- Net Assets: $1.02 billion
- Yield: 1.84%
- Expense Ratio (net): 0.90%
- Inception Date: July 11, 2006
If you expect China’s economy and market to stumble, you can use Direxion Daily CSI 300 China A Share Bear 1X ETF to short the CSI 300 Index, which consists of the largest stocks in the Chinese market.
- Avg. Volume: 13,719
- Net Assets: $17.83 million
- Yield: 3.53%
- Expense Ratio (net): 0.85%
- Inception Date: June 17, 2015
Higher interest rates tend to hurt bond prices.The Direxion Daily Total Bond Market Bear 1X ETF is designed to move inverse the Barclays Capital US Aggregate Bond Index. Note, however, that the volume is extremely low at less than 200 shares daily and the ETF is probably not ideal for short-term investing due to the lack of liquidity.
- Avg. Volume: 167
- Net Assets: $2.97 million
- Yield: 1.8%
- Expense Ratio (net): 0.49%
- Inception Date: March 23, 2011
The Bottom Line
Selling short individual stocks can be riskier than buying ETFs that short the market. With an ETF that shorts the market, investors have the diversification of shorting several stocks instead of only a single stock. As a result, the profits are tied to the fate of the entire market rather than just one company. However, If the market improves and buyers rush in, the shares of the short ETF will lose value and the result is a loss.