The Pros and Cons of Inverse ETFs (+3K Views)

Stock market can go down as well as up but I have some good news on how you can actually protect yourself from losses while making money if the markets plummet!

The comments above & below are edited ([ ]) and abridged (…) excerpts from the original article by Ron Rowland (moneyandmarkets.com)

How to “Short” the Market
There are different ways to profit from declines in individual stocks, particular sectors or the major indexes, namely:

1. Short-Selling
In a short sale, you borrow stock you don’t own and sell it. If all goes well, you’ll repay the stock loan when you can buy the shares later at a lower price. Practically speaking, this isn’t as easy as it sounds. The stock has to be available for you to borrow, and you must have a margin account. IRAs and other retirement plans aren’t allowed to use margin, so you can’t short stocks within these accounts.

2. Put Options
Put options give you the right to sell a stock or an index at a specified “strike price.” Options can be very profitable, but they’re often volatile and illiquid. Moreover, they have time value that decays the longer you hold them. Options are best for when you have a strong indication of a short-term direction. Otherwise, without professional guidance, they’re a good way to lose your shirt.

3. Inverse ETFs
With inverse ETFs you can get around many of the problems of short selling and options trading while potentially “hedging” your long positions. In other words, inverse ETFs can help offset any losses in your regular stock and ETF positions.

What’s an Inverse ETF?
It’s just an ETF in reverse. In an earlier column, I told you about SPY: the SPDR Trust that tracks the S&P 500 Index where, if you’re bullish on stocks, you can just buy SPY and your account will go up in tandem with the index. Well, the ProShares Short S&P 500 can do the same thing if you’re bearish. The ticker symbol is SH, and it tracks SPY in reverse. If the S&P 500 falls 1 percent tomorrow, SH is designed to go up by 1 percent. Nice!

You can do the same thing with other major benchmarks and sectors. Feeling bearish on the Dow? Buy the ProShares Short Dow 30 (DOG). If you think small caps are ready to fall, jump into the ProShares Short Russell 2000 (RWM).

Inverse ETF Advantages
1. they are much easier to trade. You don’t have to figure out what strike price is best or wonder whether stock is available to borrow. All you need to get started is a standard brokerage account. Plus you can trade inverse ETFs inside your IRA.
2. they have limited loss potential. In a short sale, it’s possible to lose more than your initial investment. Inverse ETFs are designed to prevent this from happening.
3. they have no time value with inverse ETFs. If you have the patience, you can wait months or years for your bet to pay off. Your ETF position won’t expire like options do.
4. they can help you protect your stock investments when the markets go down.

Inverse ETF Disadvantages
1. they work both ways. If you buy an inverse ETF and the market you’re tracking goes up, your inverse ETF will drop accordingly. So if your timing is even slightly off, you can lose money just as fast as bullish investors are making it.
2. they don’t always track their benchmarks precisely, especially over long time periods so make sure you have the right expectations.
3. inverse ETFs that use leverage have additional risk factors you need to understand before purchasing.

Conclusion
With inverse ETFs, you don’t have to stay on the sidelines as your stock investments fall in value when the bear starts to growl.

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