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Consider Alternative ETF Strategies to Hedge Potential Risks Ahead

Max Chen

This article was originally published on ETFTrends.com.

The equity markets have staged a quick rebound from the March lows, but some point to potential risks that threaten the market rally. Traders can turn to bearish or inverse exchange traded fund strategies to hedge against these potential risks ahead.

According to Goldman Sachs, the S&P 500 has rallied 39% from its March 23 low, but the market for long-dated dividend futures has risen just 7%, which reflects ongoing concerns over earnings growth and increasing chances that a Democratic sweep in the November elections could have negative market consequences like lead a reversal of the 2017 corporate tax cuts, MarketWatch reports.

Dividend futures are a type of derivative where buyers pay a discounted price today for a potential full dividend payment in the future. If the company fulfills or exceeds a certain dividend payout, the investor will earn the difference between the purchase price and the final pay. Currently, the outperforming mega-caps typically don't pay out much dividends and areas that pay larger dividends, like banks, have not performed as well.

“The uncertain future of corporate tax rates poses a key risk to corporate profitability and dividends,” Goldman analyst Cole Hunter said in a note.

Hunter also warned that polling and prediction markets are showing at least a 50-50 chance Democrats could take full control of Congress and the White House in November.

“Such an outcome could lead to a full or partial reversal of the 2017 TCJA corporate tax reform legislation,” Hunter added. “We estimate that a full reversal would lift the effective S&P 500 tax rate from 18% back to 26% and reduce our 2021 earnings-per-share forecast of $170 by $20, or 11%, to $150.”

ETF traders who are looking to protect their portfolios from potential pullbacks ahead may consider some exposure to bearish or inverse ETFs to hedge against further falls.

For example, the ProShares Short S&P500 (NYSEArca: SH) takes a simple inverse or -100% daily performance of the S&P 500 index. Alternatively, for the more aggressive trader, leveraged options include the ProShares UltraShort S&P500 ETF (NYSEArca: SDS), which tries to reflect the -2x or -200% daily performance of the S&P 500, the Direxion Daily S&P 500 Bear 3x Shares (NYSEArca: SPXS), which takes the -3x or -300% daily performance of the S&P 500, and ProShares UltraPro Short S&P 500 ETF (NYSEArca: SPXU), which also takes the -300% daily performance of the S&P 500.

Those who want to hedge against risk in the Dow Jones Industrial Average utilized inverse ETFs to bolster their long equities positions. The ProShares Short Dow 30 ETF (NYSEArca: DOG) tries to reflect the -100% daily performance of the Dow Jones Industrial Average. For the more aggressive traders, the ProShares UltraShort Dow 30 ETF (NYSEArca: DXD) takes the -200% of the Dow Jones and the ProShares UltraPro Short Dow 30 (NYSEArca: SDOW) reflects the -300% of the Dow.

Lastly, investors also hedged against a dipping Nasdaq through bearish options as well. For instance, the ProShares Short QQQ ETF (NYSEArca: PSQ) takes the inverse or -100% daily performance of the Nasdaq-100 Index. For the aggressive trader, the ProShares UltraShort QQQ ETF (NYSEArca: QID) tracks the double inverse or -200% performance of the Nasdaq-100, and the ProShares UltraPro Short QQQ ETF (NasdaqGM: SQQQ) reflects the triple inverse or -300% of the Nasdaq-100.

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