More on Double Inverse ETFs
The top gaining ETFs for the week ending January 18 in Investors Business Daily were all double inverse short funds, and their returns were 18% and up. Now, after today’s big plunge in the Chinese markets and a downward slide in Europe as well, while we were taking a holiday in the U.S., there’s sure to be more interest in these double short funds. (See the earlier blogpost, Time to Let the Dog In?)
How do double inverse ETFs work? Instead of shorting all the stocks in an index, they use derivatives, which include futures contracts, options, and swaps, (A swap means you sell one security and buy a comparable one). Their value is derived from the value of an underlying security, commodity or other financial instrument. Derivatives don’t have the trading costs associated with shorting.
With swaps, there is a payment of interest. Futures are “margined” or leveraged, which means a small amount of money is used to garner a greater return. For an ETF to give back 100% of a negative return of an index, the ETF need only invest 10% of its cash into the futures. If the ETF is to generate a 200% negative return, it invests 20% of its money into the futures. The remaining assets, 90% or 80%, are in short-term notes, which pay interest.
Confusing? There are more detailed explanations in these articles:
Inverse (Short) Market Cap ETFs
The double inverse ETFs actually pay quarterly dividends with the money earned in interest. The reason to own them, though, is to protect a portfolio against downside risks, which are now looming large. Or to take money out of a bear market.