Best inverse and short ETFs — here’s what to know before buying them

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Inverse exchange-traded funds (ETFs) are often used by contrarian traders looking to profit from the decline in value of an asset class, such as an index. These risky investments, also known as short ETFs, can be valuable for seasoned market pros as increased volatility provides short-term opportunities to get in and out of positions. However, while these investments can potentially be lucrative, they are definitely not for everyone.

Depending on your financial situation and risk tolerance there are various strategies for trading inverse ETFs. For example, some traders use short ETFs to hedge against falling prices in other positions. So, as one position drops, the other one rises, capping the potential losses.

Investors should note that inverse short ETFs reset daily. So, holding them for longer than a day could compound the potential losses.

Your level of financial knowledge and engagement with your investments are important factors to consider carefully. Even experienced traders often start small and have an exit strategy. The key is to stick to your plan and know when to close out of a losing position.

Below we highlight some of the most popular short ETFs, explain the concept of short selling and leveraged trading, and discuss some key considerations to keep in mind if you’re thinking about buying an inverse ETF.

Top inverse ETFs

The following inverse ETFs, also known as short ETFs, are some of the most widely traded.

ProShares UltraPro Short QQQ (SQQQ)

SQQQ offers three times daily downside leveraged exposure to the tech-heavy Nasdaq 100 index. This ETF is designed for traders with a bearish short-term view on large-cap technology names.

Fund issuer: ProShares

Expense ratio: 0.95 percent

Average daily volume: ~70 million shares

Assets under management: ~$1.75 billion

ProShares Short Ultrashort S&P500 (SDS)

SDS offers twice-daily leveraged downside exposure to the S&P 500 index. This ETF is designed for traders with a bearish short-term view on large-cap U.S. companies across sectors.

Fund issuer: ProShares

Expense ratio: 0.91 percent

Average daily volume: ~16 million shares

Assets under management: ~$609 million

Direxion Daily Semiconductor Bear 3x Shares (SOXS)

SOXS provides three times daily leveraged downside exposure to an index of companies involved in developing and manufacturing semiconductors. This ETF is designed for traders with a bearish short-term outlook on the semiconductor industry.

Fund issuer: Rafferty Asset Management

Expense ratio: 1.11 percent

Average daily volume: ~8.2 million shares

Assets under management: ~$126 million

Direxion Daily Small Cap Bear 3X Shares (TZA)

TZA provides three times daily leveraged downside exposure to the small-cap Russell 2000 index. This ETF is designed for traders with a bearish short-term outlook on the US economy.

Fund issuer: Rafferty Asset Management

Expense ratio: 1.10 percent

Average daily volume: ~8.2 million shares

Assets under management: ~$357 million

ProShares UltraShort 20+ Year Treasury (TBT)

TBT offers twice-daily leveraged downside exposure to the Barclays Capital U.S. 20+ Year Treasury Index. This ETF is designed for traders who want to make a leveraged bet on rising interest rates.

Fund issuer: ProShares

Expense ratio: 0.92 percent

Average daily volume: ~3.9 million shares

Assets under management: ~$1.5 billion

What is short selling?

Short selling is an investment strategy used by traders to speculate on the price decline of an asset.

In short selling, traders borrow an asset so they can sell it to other market participants. The objective is to buy back the asset at a lower price, return it to the original lender, and pocket the difference. However, when the asset price increases, traders are on the hook to buy it back at a higher price.

Short selling is a risky strategy because the price of an asset can essentially rise to infinity.

For example, if you buy a company’s stock for $10 and the company declares bankruptcy, your potential loss is $10. However, if you short the same stock, and the company gets acquired, causing the shares to jump to $300, your potential loss is exponentially bigger as you are obligated to buy back the stock and return it to the lender.

The concept of short selling gained notoriety earlier this year when shares of GameStop (GME) jumped from around $40 to nearly $400 in a few days as short sellers were forced out of their positions.

What is leveraged short selling?

Leveraged short-selling lets traders use debt to increase their buying power. With the additional funds, traders often purchase futures and other financial derivatives to speculate on the stock or bond markets.

By taking additional risk, traders seek to capture outsized returns.

Leveraged trading is also known as margin trading. The strategy can be risky because those bets often become outsized losses when a trade goes sour. Plus, traders need to pay back the borrowed funds along with any transaction fees.

Apart from these factors, traders have to pay short-term capital gains taxes, primarily if the assets are in a taxable account. In addition, multiple fees are associated with trading on margin and short selling.

How traders use leveraged short ETFs

With leveraged short ETFs, traders aim to magnify investment returns. Think of leveraged ETFs as ETFs on steroids.

For example, the ProShares UltraPro Short QQQ ETF (SQQQ) uses swaps and futures to provide three times the inverse daily performance of the Nasdaq 100 index. So, conceptually, if the Nasdaq 100 is down 1 percent, this short ETF could be up 3 percent. It all depends on the type of leverage used and how it connects to the news causing the move.

While that might sound tempting, potential losses can be just as pronounced. Financial derivatives, like other exotic market products, react differently to negative news. Using the hypothetical example above, when the Nasdaq jumps 2 percent, a leveraged short ETF could plunge around 6 percent, depending on the underlying assets used.

How to buy inverse/short ETFs

There are plenty of ETF screening tools, including those provided by most brokerage firms. While factors like management fees and daily trading performance are important considerations, you should thoroughly review the fund’s prospectus.

As you narrow your options, the key features to consider are:

Leverage: This metric is qualified by a numeral followed by the letter “x.” So, a fund like the Direxion Daily S&P 500 Bull 3X Shares (SPXL) offers three times the performance of the S&P 500 index. In addition, the leveraged expected return is for a single day, not cumulative over time.

Expense ratios and fees: Compared to traditional funds, short ETFs carry higher fees. Keep in mind that those costs can add up, so make sure to compare apples to apples and read the fine print.

Trading volume: The more liquid a fund is, the easier it will be to buy and sell. Look at how average trading volume compares to similar ETFs.

Fund performance: Numbers don’t lie. While doing your research, take a look at a fund’s daily performance. But remember, these funds are not intended as a buy-and-hold strategy.

Assets under management (AUM): Many investors use this figure as a vote of confidence to assess other investors’ engagement with a particular ETF. Along with AUM figures, it might be helpful to check the longevity of the fund.

Fund issuer: Brands are powerful. And that’s no different in the ETF space. Some investors feel comfortable investing only with large asset managers, while others see the value in newcomers. Decide what works for you and your financial needs.

Use these criteria as a starting point to do more research. For example, some traders find it helpful to study the daily performance of inverse/short ETFs before committing any money.

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Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.