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ETFs to Hedge Against a Retreating S&P 500

editor@etftrends.com (ETF Trends)

With market moves picking up after the summer lull, the stock market declined as investors position for a potential interest rate hike following next week’s Federal Reserve meeting. Exchange traded fund investors who are wary of further slips in equities may consider inverse or bearish strategies to hedge against further drawdowns.

Prior to the recent selling last week, the S&P 500 index had registered no single 1% decline for 52 consecutive trading sessions, with the index and related SPDR S&P 500 ETF (SPY) both trading near historic highs. Since Thursday, SPY has fallen off about 2.4%.

More importantly, technical traders may have noticed that the S&P 500 and SPY have both dipped below their short-term 50-day moving averages, which suggests that the equities market are stuck in weak short-term momentum. Further selling pressure would be needed before the market’s internal measures push down to oversold levels.

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As we head toward a quiet period for the Federal Reserve ahead of the Wednesday, September 21 Federal Open Market Committee meeting announcement, interest rate speculation will continue to run rampant.

Consequently, with uncertainty rising, investors may consider a hedge against further market turns. There are a number of bearish or inverse ETF options with varying levels of leveraged exposure to capitalize off of further weakness in the S&P 500.

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For instance, the ProShares Short S&P500 (SH) and Direxion Daily S&P 500 Bear 1x Shares ETF (SPDN) take a simple inverse or -100% daily performance of the S&P 500 index. Over the past week, SH rose 1.0% and SPDN added 0.7% while the S&P 500 index declined 0.9%.

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. Over the past week, SDS gained 1.7%, SPXS increased 2.4% and SXPU advanced 2.3%.

Potential investors should be aware of the risks associated with these inverse products. These ETFs rebalance on a daily basis, so the inverse funds may not perfectly reflect their intended strategies over long periods due to compounding issues as a result of the daily rebalancing.

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In Trending markets that move consistently in a single direction, compounding may benefit inverse ETFs. However, in more volatile markets when securities experience greater oscillations, an inverse ETF may underperform its intended -1x, -2x or -3x multiples compared to a benchmark..

Full disclosure: Tom Lydon’s clients own shares of SPY.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.