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ETF Strategies to Hedge Against a Correction

editor@etftrends.com (ETF Trends)

The equities market has been in a sideways trading range and some observers are warning that we are in for a correction as the summer rally losses momentum. Consequently, investors may consider an exchange traded fund strategies to hedge their portfolios from a pullback in the equities market.

UBS AG equity technical analysts argue that the U.S. stock market is heading for a significant correction as a number of technical signals indicate a turn in the environment, citing weak U.S. inflation expectations, along with rising correlations between asset classes, among others, reports Sid Verma for Bloomberg.

Inflation levels have been tepid, despite expectations that the Federal Reserve will keep rates lower for longer, which has fueled the stock market rally. The five-year break-even inflation rate is hovering around 1.35%, compared to 1.62% in late April. Higher inflation expectations have usually suggested greater expectations for aggregate demand and expected real growth.

SEE MORE: ETFs to Hedge Risks in More Volatile Conditions Ahead

However, UBS AG analysts, led by Michael Riesner, showed that U.S. stock rally has not been accompanied by an increase in the Treasury market’s forecast for inflation, which suggests that the recent push toward record highs is mature and at risk of a correction next month.

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“The most important point is certainly the major divergence/gap that has been developing between US inflation expectations and the SPX,” according to UBS. “Historically seen, inflation expectations are highly correlated to risk. If we just look at this relationship and the huge gap that has been forming over recent months, this is one of the few indicators that really questions the whole July breakout campaign of the SPX.”

Moreover, the analysts contend that stocks could hit a cyclical top in September given the depressed volatility or ongoing complacency as reflected by the CBOE Volatility Index, or so-called VIX.

“As an investor we would use the current low volatility environment to buy protection and/or we would generally be a buyer of volatility particularly on the FX side and in gold, where it is very likely to see significant moves over the next few weeks!” the analysts added.

Consequently, investors can turn to VIX-related and inverse stock ETFs as tactical, short-term trades to hedge the market risks.

For instance, the REX VolMAXX Long VIX Weekly Futures Strategy ETF (VMAX) , iPath S&P 500 VIX Short Term Futures ETN (VXX) and ProShares VIX Short-Term Futures ETF (VIXY) have been inching higher, with the VIX now hovering around 13.65. More aggressive traders have turned to the leveraged ProShares Ultra VIX Short-Term Futures (UVXY) .

SEE MORE: VIX, Volatility ETFs Reveal an Overly Complacent Market

Additionally, there are a number of bearish or inverse ETF options with varying levels of leveraged exposure to capitalize off a weakening S&P 500 as well. The ProShares Short S&P500 (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 (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 (SPXS) , which takes the -3x or -300% daily performance of the S&P 500, and ProShares UltraPro Short S&P 500 ETF (SPXU) , which also takes the -300% daily performance of the S&P 500.

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