What Are Inverse ETFs?

Inverse ETFs are exchange-traded funds that generate profits in the direction opposite to the value of the underlying assets or derivatives. This means that if the underlying index decreases in value by 5 percent, the inverse ETF makes a profit of 5 percent. Inverse ETFs are designed to deliver daily returns on the changes in value of the underlying assets, but they do not provide consistent returns over the long-term.

Buying an inverse ETF is considered to be less complicated, less expensive, and less perilous than selling short a stock or an index fund. Buying an inverse ETF does not involve a margin account or interest charges on loaned shares. Plus, these funds can be purchased in retirement accounts and other tax-deferred investment accounts where selling a stock or fund short is not allowed.

The major advantage of inverse ETFs is that they allow a trader to make daily returns when asset prices fall. While inverse ETFs do not require traders to hold margin accounts, which is a requirement when shorting investments, they function exactly the same as short positions. This makes them ideal for traders who are unable to open shorting accounts but want a short position on an asset.

A significant disadvantage associated with inverse ETFs is their low popularity, which sometimes results in a lack of liquidity. A trader should consider purchasing inverse ETFs as a hedge against investments in industries where the trader has identified the existence of a downside risk. Another reason for buying inverse ETFs is their ability to help a traders limit their risk while offering all the benefits of a short position.