New Trade for December 22nd, 2021

Stocks dipped this morning, giving back some of the gains from yesterday’s relief rally as concerns over the rapidly spreading viral wave grew.  So far this week, the S&P 500 has whipped more than 2% in both directions.  

Usually the calmest month of the year, this December is on pace to be the most volatile month of 2021.  Wall Street’s so-called “fear gauge,” the CBOE Volatility Index, spiked above 35 earlier this month and has stayed above 20.  With the S&P just shy of its record-high amid potentially thin trading volume, the coming days are expected to be a rollercoaster.  

Today we’ll discuss an important tool to have in your tool kit in times of heightened volatility.  This valuable tactic can be used as a hedge and also turn a quick profit when the market makes significant moves.  

Traders who are looking to benefit from sliding stocks often turn to short-selling.  The main risk of traditional short-selling is that while profit is capped (a stock can only fall to zero), the risk is theoretically unlimited.  Of course, other tactics can be used to cover a position at any time, but with a short-selling position, inventors are at risk of receiving margin calls on their trading account if their short position moves against them. 

Inverse or “short” ETFs are another option that allows you to profit when a particular investment class declines in value.  Some investors use inverse ETFs to profit from market declines, while others use them to hedge their portfolios against falling prices.  

Over short periods, you can expect that the inverse ETF will perform “the opposite” of the index, but a disconnect may develop over longer periods.  Inverse ETFs will decline as an asset appreciates over time.  For that reason, inverse ETFs typically are not seen as good long-term investments. Furthermore, frequent trading often leads to an increase in fund expenses, and some inverse ETFs have expense ratios of 1% or more.  

When approached correctly, inverse ETFs can be excellent day-trading candidates and highly effective short-term hedging tools.  There are several inverse ETFs that can be used to profit from declines in broad market indexes, such as the Russell 2000 or the Nasdaq 100.  Also, there are inverse ETFs that focus on specific sectors, such as financials, energy, or consumer staples.

With $4 billion in assets, the ProShares Short S&P 500 (SH) is the largest inverse fund by value.  Commonly used by investors as a hedging vehicle, the fund strives to deliver the inverse performance of the S&P 500 (SPX).  If you’re concerned about the stock market falling, then this fund that moves in the opposite direction of the largest 500 U.S. corporations is the simplest way to protect yourself.   

It’s important to note that SH is designed to deliver inverse results over a single trading session, with exposure resetting on a monthly basis.  Investors considering this ETF should understand how that nuance impacts the risk/return profile and realize the potential for “return erosion” in volatile markets.  SH should definitely not be found in a long-term, buy-and-hold portfolio.  The fund comes along with an expense ratio of 0.9%.

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