3 S&P 500 Inverse ETFs To Hedge Your Portfolio Against A Looming Correction

how to hedge a portfolio

Summary

  • Weakness in key economic indicators continue to pour in and investors should hedge portfolios in preparation for a correction.
  • With the last full-scale market correction ending in 2011, the market is overdue.
  • Inverse ETFs SH, SDS and SPXS provide investors with flexibility in the size and magnitude of their hedging strategies.

Correction Chatter

Resounding whispers of a market correction have been heard for weeks now, and it seems these whispers are growing louder as weak economic data continues to pour in. As the market grows increasingly nervous, investors need to find ways to safeguard the returns they've accumulated from the recent bull market. Here are a few economic lowlights that are causing the worry: a 2.8% decline in earnings for S&P 500 companies relative to last year, a 5.5% jobless figure. and a decline in manufacturing activity for the fifth consecutive month. So, how have investors reacted? Many have begun to add inverse ETFS to their portfolios, while others have begun hedging with S&P 500 puts. As of the beginning of April, the number of outstanding put options more than double the number of outstanding calls, with 90% of the most active S&P 500 contracts being in favor of bearish activity, according to Bloomberg .

With all the talk of a market correction on the horizon, the million dollar question is when will it actually materialize? Well, it seems as though it could be sooner rather than later, especially if we see even more weak economic indicators in the coming weeks. Piling it on, news broke last week that the Federal Reserve of Atlanta is predicting 0.0% economic growth in the U.S. for the first quarter. This change in estimate follows reports of declining retail sales and very little consumer spending in February. These results come in stark contrast to estimates that pointed towards consumer spending growth for the year. So far, we've seen the opposite, causing the Atlanta Fed to react by slashing its growth estimate of 1.9% for the first quarter all the way to zero.

Chart from Yahoo Finance

Another reason to worry is simply the fact that we're overdue for a correction. Since 1945, there have been 27 full-scale market corrections. This equates to a correction approximately every 2.5 to 3 years. The last correction we saw ended in September of 2011, which is just over 3.5 years ago. If we know anything, it's that history often repeats itself. Although, we also know that averages are simply that, averages, and it could be months or years before we see another correction. Regardless, when the time does come, it makes sense to have your portfolio hedged with an inverse ETF. Here are three inverse ETFs of varying magnitude that will provide a necessary hedge to your portfolio. However, bear in mind (pun intended), these can be risky investments, and please invest with caution. Additionally, please be aware that inverse ETFs seek to achieve their investment objectives daily. and returns are compounded. Therefore, looking at the ETFs' long-term results may be misleading and they likely will not reflect the desired inverse of S&P 500 returns.

-100% Relative

to S&P 500 - the ProShares Short S&P 500 ETF (NYSEARCA:SH )

Chart from Yahoo Finance

SH seeks to provide investors with a daily return that is approximately 100% inverse of the S&P 500, which is illustrated by its beta of -0.97. The ETF has 0.95% Net Expense Ratio, which is broken down into 0.75% of investment advisory fees and 0.20% labeled as other expenses. Instead of the traditional hedging technique of directly shorting stocks, the fund purchases financial derivatives that provide a similar hedge. The primary derivatives that the fund seeks are futures, swaps, and short-term cash instruments. Of the three options, SH is the least volatile and may be the safest choice in the case that a correction does not take place. In addition, SH seems to be one of the more popular inverse ETFs as of late, as its 10-day average volume has increased by almost 42% to 3,237,703.

-200% Relative to S&P 500 - the ProShares UltraShort S&P 500 ETF (SDS )

Chart from Yahoo Finance

Since July 2006, SDS has sought a 200% inverse return of the S&P 500 daily, with a beta of -1.886. The fund has a Net Expense Ratio of 0.89%, making it the least expensive of the three. Additionally, SDS is the most popular of the three and has seen nearly three times the 10-day average volume that the others have been experiencing, coming in at 8,747,497. SDS is an aggressive play, but if used properly could provide some very nice gains, while remaining relatively much less riskier than 300% inverse picks such as SPXS. This may be a good pick for those looking to take on the paradox of hedging through a relatively high-risk ETF.

-300% Relative to S&P 500 - Direxion Daily S&P 500 Bear 3X Shares ETF (NYSEARCA:SPXS )

Chart from Yahoo Finance

SPXS is the most aggressive choice of the three. The fund has a beta of -2.97 and a daily target of -300% relative to the S&P 500, which is offered at a Net Expense Ratio of 0.99%. Despite its risky nature, SPXS will provide the largest return if a market correction takes place and it could offer quick returns of 30% or greater. However, the volatility of this ETF makes purchase timing critical and mistiming could result in sizeable losses. Thus, making it a high-risk, high-reward ETF that may not be the best option for investors looking for a safe hedge. However, it could be a tool for experienced investors with an eye for timing the market.

Comparison

Below are a few comparison figures. As you can see, the three ETFs mirror the performance of one another, differing only in magnitude. Thus, offering a hedge for a broad range of portfolios.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More. ) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: m.seekingalpha.com

Category: Forex

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