How To Profit From A Market Correction With Inverse ETFs

by: Zacks Funds

Stocks have been slammed lately and 10% losses have been routinely seen across the board. And while trading has smoothed out a little bit in recent sessions, the prospect of a continued downturn cannot be ruled out at this time.

Fortunately with ETFs, investors can bet on a downturn in key market segments by using inverse ETFs. These funds give the opposite of what their underlying benchmarks do on a daily basis and thus have been big winners in the recent turmoil. Consider how the following ETFs have done in this difficult time (one week trading from 8/19-8/25):

  • Short China: The Direxion Daily CSI 300 China A Share Bear 1X Shares (NYSEARCA:CHAD) is up 21% for A-Shares market, the ProShares Short FTSE China 50 ETF (NYSEARCA:YXI) with an 11.5% gain.
  • Short Nasdaq: the ProShares Short QQQ ETF (NYSEARCA:PSQ) up 12.65%.
  • Short Oil & Gas: the ProShares Short Oil & Gas ETF (NYSEARCA:DDG) up 12.5%.

Beyond these funds, it is also important to consider volatility (via the iPath S&P 500 VIX Short-Term Futures ETN (VXX) in this period. This ETN has been a star performer including an over 60% gain in the rough five day stretch in question. However, the longer term performance here has been atrocious so definitely don't hold it as a long term investment.

Other Factors to Consider

If you are looking for longer term picks, make sure to zero in on the lower volatility space or ETFs that incorporate volatility into their asset profile. Great examples here include the iShares MSCI USA Minimum Volatility ETF (USMV) (which has a low volatility focus) and the PowerShares S&P 500 Downside Hedged Portfolio ETF (NYSE:PHDG) which incorporates volatility as part of its asset mix. Either of these look to be far better for longer time periods than the inverse funds listed above.

That is because inverse, and leveraged inverse, ETFs suffer from a daily compounding feature which makes their longer term performance deviate from what you might expect. While this can actually help you in trending markets, it can shred returns in volatile and oscillating markets which we may soon find ourselves in shortly.

But for more on the underappreciated inverse ETF space and which funds have made a killing in the correction, make sure to watch our short video on the topic below: