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What Is an Inverse ETF and How Do I Make Money Selling Them?

June 15, 2021 by Daniels Trading| Futures 101

An exchange-traded fund, or ETF, is a type of security that is traded on formal stock exchanges such as the NYSE or NASDAQ. Like mutual funds, exchange-traded funds are made up of various asset allocations, but they may be traded as stocks are during the standard and extended sessions.

So what is an inverse ETF? Read on to find out the answer to this question and to learn whether these unique instruments are right for your financial situation.

What Is an Inverse ETF?

An inverse ETF is an exchange-traded fund that is designed to deliver returns opposite of the underlying index or asset class. Essentially, it is a security that provides traders with short-side market exposure. Profits are derived from falling asset prices, not the typical “buy low, sell high” mantra of Wall Street. Accordingly, an inverse ETF is commonly referred to as a “short ETF” or “bear ETF.”

We’ve been assisting our clients in making sound trading decisions for over 25  years.  Trust a Daniels Trading broker to help you reach your trading objectives in  any market.

To secure bearish market exposure, inverse ETFs consist of various derivative products. By taking short positions in select futures, options, forwards, and swaps, fund managers can essentially “sell” an underlying index or asset class.

Anyone considering the question of “What is an inverse ETF?” should be aware of the two basic types:

  • Standard: A standard inverse ETF aims to provide 1X negatively correlated returns on an underlying index or asset class.
  • Leveraged: A leveraged or “geared” inverse ETF aims to provide a multiple of negatively correlated returns on an underlying index or asset class. Leveraged inverse ETFs typically return -2X or -3X returns.

Here are a few of the most prominent inverse ETFs listings:

Product Index Asset Class
ProShares UltraPro Short QQQ NASDAQ -3x
ProShares Short S&P 500 S&P 500 -1x
Direxion Daily Small Cap Bear 3X l Russell 2000 -3x
DB Gold Double Short Gold -2x
ProShares UltraShort Bloomberg Crude Oil Energy -2x

The Ins and Outs of Inverse ETFs

As with any security, there are nuances involved with trading inverse ETFs. In fact, the first chapter in any book titled What Is an Inverse ETF? should explain that these products are intended to be short-term trading vehicles. Because inverse ETFs use derivatives to assume bearish market positions, they must be rebalanced every day to reach their stated objective. This can lead to diverging intermediate-term returns and can make holding inverse ETFs problematic over time.

Physically trading inverse ETFs is very similar to buying and selling shares of stock. To illustrate, assume that Gerry the gold trader believes that the U.S. Federal Reserve (Fed) is planning a ¼-point surprise interest rate hike. The Fed’s actions would likely send the price of gold toppling as traders begin to price in a stronger USD. To get in on the action, Gerry decides to short the bullion market with an inverse ETF following the below scenario:

  1. Near-term CME gold futures are trading in the neighborhood of $1,875.00.
  2. Gerry buys 100 shares of Proshares Inverse Gold ETF (GLL) at $30.00 per share.
  3. Once the trade has been executed, Gerry has secured a -2X short position in relation to the Bloomberg Gold Subindex.
  4. If the value of gold falls, the price of the ProShares Inverse Gold ETF (GLL) is in a position to rally. Should price reach an acceptable level, Gerry can elect to sell the inverse ETF and realize a profit.
  5. In the event that bullion appreciates in value, prices of the ProShares Inverse Gold ETF will fall. Unfortunately for Gerry, this scenario prompts a capital drawdown and may generate a realized loss.

Essentially, Gerry has shorted gold from the current market price ($1,875.00). If the value of gold falls, then the price of GLL will increase and generate market share.

However, it is important to understand that Gerry’s bearish exposure to the gold market is indirect in nature. This means that the combination of derivatives employed by the GLL may or may not track the price of gold accurately. In addition, the margin rules put forth by the U.S. Financial Industry Regulatory Authority (FINRA) are strict regarding inverse leveraged ETFs. As a result, Gerry’s ability to apply leverage to the short side of the gold market is far less than that found in the futures markets.

If you’re still confused about how to answer the question of what an inverse ETF is, think of it this way: An inverse ETF is a means of indirectly shorting the market with limited leverage. It’s as simple as that.

Are Inverse ETFs Right for You?

One of the great things about modern finance is the wide variety of opportunities available. Active traders can profit from buying or selling many different shares and ETFs, as well as standard futures and options contracts.

To learn more about the possibilities of this exciting time in finance, speak with a Daniels Trading broker today.

Futures vs. ETFs Online Course

Filed Under: Futures 101

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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