Hedging Downside Risk With ETFs

Includes: QID-OLD, SDS
by: Mick Flaherty

Ever been in a position when you think the market is faltering or going down but you don't want to liquidate your holdings to prevent losses? A simple "hedging" technique is in order. In commodities, if a firm owns a cash position in a commodity - corn for example - they will use the futures market to sell contracts in corn futures to lock in prices i.e., if the price of the underlying commodity falls, it will be mostly offset by the short position in the futures market.

A simple way to do the same thing in the stock market is to use the Ultra-Short ETFs for the S&P (NYSEARCA:SDS) and Nasdaq (NYSEARCA:QID-OLD) indices. In essence, if either of these indices go down, the relevant ETF will go up accordingly. If most of your holdings are Tech stocks then the QID is for you. If you have a more diversified portfolio then use the SDS. Buys of both may be in order.

An exact hedge is unlikely; if you own 100 shares of Intel (NASDAQ:INTC) for example, it may not correspond exactly with QID in a market selloff. The point is to ameliorate the overall position. Same deal with the SDS. I recently bought both and am pleasantly surprised at the results. I'm actually making more in the hedge position than I'm losing in the overall portfolio.

You can use stops, options and Technical Analysis just as you would any stock. What's that expression about an ounce of prevention?

Disclosure: none