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What Is an Inverse ETF?
An inverse ETF is an exchange traded fund (ETF) constructed by using various derivatives to profit from a decline in the value of an underlying benchmark. Investing in inverse ETFs is similar to holding various short positions, which involve borrowing securities and selling them with the hope of repurchasing them at a lower price.
An inverse ETF is also known as a "Short ETF" or "Bear ETF."
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Key Takeaways
- An inverse ETF is an exchange traded fund (ETF) constructed by using various derivatives to profit from a decline in the value of an underlying benchmark.
- Inverse ETFs allow investors to make money when the market or the underlying index declines, but without having to sell anything short.
- Higher fees tend to correspond with inverse ETFs versus traditional ETFs.
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Understanding Inverse ETFs
Many inverse ETFs utilize daily futures contracts to produce their returns. A futures contract is a contract to buy or sell an asset or security at a set time and price. Futures allow investors to make a bet on the direction of a securities price.
Inverse ETFs' use of derivatives—like futures contracts—allows investors to make a bet that the market will decline. If the market falls, the inverse ETF rises by roughly the same percentage minus fees and commissions from the broker.
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Inverse ETFs vs. Short Selling
An advantage of inverse ETFs is that they do not require the investor to hold a margin account as would be the case for investors looking to enter into short positions . A margin account is one where a broker lends money to an investor to trade. Margin is used with shorting—an advanced trading activity.
Investors who enter into short positions borrow the securities—they don't own them—so that they can sell them to other traders. The goal is to buy the asset back at a lower price and unwind the trade by returning the shares to the margin lender.
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