Inverse ETFs are unique financial instruments that allow traders to profit from the decline in the value of underlying assets or indices. They are designed to move in the opposite direction of their benchmarks, making them valuable tools for hedging against market downturns or speculating on short-term price declines.
Whether you're an experienced trader or new to the world of ETFs, understanding the best inverse ETFs can be a crucial part of managing your investment portfolio.
What is an Inverse ETF and how does it work?
An inverse ETF (Exchange Traded Fund) is a type of investment fund that is designed to perform inversely to a specific index or benchmark. Essentially, it aims to make a profit when the index/asset/benchmark it is tracking declines in value.
For example, an inverse ETF would obtain a positive return if the benchmark it replicates obtains a negative daily return, that is, if the index drops 2% in a day, the inverse ETF will rise 2%. Similarly, when the index rises, the inverse ETF falls.
As you may have already realised, investing in inverse ETFs is similar to maintaining short positions, which involve borrowing securities and selling them in the hope of repurchasing them at a lower price.
These ETFs can be useful for hedging portfolios, either tactically or strategically, and for speculating on short-term price declines.
What is a leveraged inverse ETF?
A leveraged inverse ETF aims to deliver multiple times the opposite return of its benchmark index. For example, a 2x leveraged inverse ETF aims to return twice the opposite of the index's daily performance. If the index drops 1%, the ETF aims to gain 2%.
For example, Xtrackers S&P 500 2x Inverse Daily Swap UCITS ETF 1C, the ETF's name already indicates that it follows the daily inverse return of the S&P500 with double leverage, that is 2x.
Advantages of inverse ETFs
The advantages of inverse ETFs are as follows:
- Profit when market trends are bearish
- It is a way to hedge our portfolio
- The leverage effect allows us to increase profits
- Wide variety of inverse ETFs to choose from
- Highly liquid
Disadvantages of inverse ETFs
- High risk since broad market indices tend to rise more than they fall and, unlike decreases where the limit is zero, rises have no limits (hence, virtually unlimited losses).
- Inverse ETFs can generate substantial losses if held in the long term (not suitable for medium or long-term strategies)
- They usually have higher costs compared to traditional ETFs.
- Long-term charts of inverse ETFs typically show a negative trend because these funds are designed to provide returns that move in the opposite direction of their underlying indices or assets. As markets generally have an upward bias over the long term, inverse ETFs aim to capture the inverse of that trend
Best inverse ETFs
Next, we are going to analyse the best inverse ETFs according to the tracked assets, such as stock indices, commodities, equities and fixed income.
Best inverse ETFs: stock indices
|Index it replicates
|Xtrackers S&P 500 2x Inverse Daily Swap UCITS ETF 1C
|L&G DAX Daily 2x Short UCITS ETF
|FSE Short DAX
|Xtrackers EURO STOXX 50 Short Daily Swap UCITS ETF 1C
|Dow Jones Euro Stoxx 40 Short
|Xtrackers FTSE 100 Short Daily Swap UCITS ETF 1C
|FTSE 100 Short
|Lyxor IBEX 35 Double Inverse Daily UCITS ETF – Acc
Best inverse ETFs: commodities
|WisdomTree Petroleum 2x Daily Leveraged (EUR) | LPET
|SG ETC Natural Gas Collateralized | GAS1L
|SG ETC WTI Oil Collateralized (EUR) | OIL1L
|WisdomTree Coffee 2x Daily Leveraged (EUR) | 4RT2
|WisdomTree Agriculture 2x Daily Leveraged (EUR) | 4RTR
Best inverse ETFs: equity
|Leverage Shares -1x Short Peloton ETC (EUR) | SPTE
|GraniteShares 3x Short Netflix Daily ETP (EUR) | 3SNE
|Leverage Shares -1x Short PayPal ETP (EUR) | SPYE
|Leverage Shares -1x Short Roku ETC (EUR) | SROE
|Leverage Shares -1x Short Zoom ETP (EUR) | SZME
Best inverse ETFs: fixed income
|WisdomTree US Treasuries 30Y 3x Daily Short (EUR) | UL3S
|Lyxor BTP Daily (-2x) Inverse UCITS ETF Acc | BTPS
|Xtrackers II Eurozone Government Bond Short Daily Swap UCITS ETF 1C | DXSV
|WisdomTree Gilts 10Y 1x Daily Short | 1GIS
|Xtrackers II iTraxx Crossover Short Daily Swap UCITS ETF 1C | DXST
Learn more about ETFs
Investing in inverse ETFs can be a great opportunity, but we must take into account certain risks, as we are betting against the market.
Leverage could generate high returns, but the risk of losses is also multiplied.
It is recommended to trade inverse ETFs in the short term, with the appropriate risk management strategies, and avoid medium and long positions.
How do inverse ETFs work?
Inverse ETFs use derivatives like futures and swaps to achieve their goal of inverse performance. These financial instruments allow the ETF to profit from declines in the underlying index.
Are inverse ETFs suitable for long-term investing?
No, inverse ETFs are generally not suitable for long-term investing. They are designed for short-term trading because their performance can diverge significantly from the inverse of the index over longer periods.
Can inverse ETFs be used for hedging?
Yes, Inverse ETFs can be used for hedging against market downturns. If an investor holds stocks that are expected to decline, an inverse ETF can help offset some of those losses.