Leveraged and inverse ETF's continue to give traders more and more options for putting on positions that may be cheaper and easier to establish than old school methods. Investors these days often use short positions in stocks or ETF's in order to bet against specific sectors or indexes, but inverse ETFs can accomplish that goal as well.
Each approach has its its pro's and con's leaving investors with the question: Should I short an ETF or buy the inverse ETF? Today we look deeper at this topic.
Short selling involves using margin within a brokerage account to borrow shares to sell in the open market. A borrow fee is can be charged by the broker for the shares and this fee can be fairly high if the shares are in short supply. Without availability of margin in your account you may only have the option of buying the inverse product.
Inverse ETF's generally utilize derivatives contracts in order to create synthetic short positions. Therefore, no shares are being sold short in inverse ETF's. These products require only a brokerage account to buy. Primarily because of the costs that can be involved, both inverse ETF's and short sales are typically held for very short time periods and rarely make sense as long-term holdings.
Short selling makes sense when they want to take a position in an individual company. ETF's are invested in broad baskets of securities and aren't of help for investors wishing to bet against an individual stock. Companies such as Apple
Short selling may also have a cost advantage over inverse ETF's, depending on the security being shorted. Inverse ETF's typically carry expense ratios of 1% or more annually, due to the frequent daily trading of futures contracts involved. For products with widely available shares for shorting, the cost of establishing a short position is generally much cheaper than using ETF's.
So when does Inverse ETF's make sense?
Trades in inverse ETF's generally aren't as complicated to execute as short sales. Short selling involves receiving margin approval within a brokerage account, whereas trading an inverse ETF requires only a brokerage account. Short selling is often not intuitive for the average investor, which could potentially lead to unintentional losses if not executed correctly.
Inverse ETF's also don't have the risk that comes from potential margin calls or dividend payments. If the short position begins losing value, the broker may make a margin call, requiring additional capital to be contributed to the account. Additionally, traders are responsible for making dividend payments on short positions. Both of these are potential costs that aren't typically associated with inverse ETF's.
