When markets fall there are a number of ways to exploit the drop and find winners. Before inverse ETFs became available, the most common ways to take advantage of a drop was to short sell or use Put options. It is important to understand a couple key differences between these choices as you look grabbing wins as prices fall.
Put options offer an advantage in that they provide leverage. This means their value can increase exponentially as the underlying asset declines. Depending on the speed of the drop, a put option can grow 2, 4 even 10x as the underlying drops even a fraction of that amount. If the underlying whipsaws, however, the risk can wipe out the entire value of the put. This is important and must be considered prior to placing trades.
Another Challenge with Puts are the requirements to trade options. The account size and trading requirements are very important and help ensure people are prepared to trade options but can be a hurdle as you get started.
Inverse ETFs can be a great alternative. We have talked about these in the past (read the articles here) and basically inverse ETFs go up as the assets they are based on go down. The most common ETF that is trade is the SPY. Here is a chart of SPY that shows the recent drop.
You can see the steady decline since early Aug. Now take a look at SPXU. This is an inverse ETF that is based on the S&P. But it has another advantage…
Notice it has been on the rise in that same timeframe. The unique aspect of SPXU is that it is a leveraged inverse ETF. That means the price move 3x the move of the underlying. While it doesn’t offer the huge leverage potential of a put option, it is a nice way to take advantage of a drop. Plus, these can be traded from a regular equity brokerage account.
There are many other nuances between these choices so be sure to do some research to find out what best fits your trading profile. We’ll be watching these inverse ETFs as the market continues to look for a bottom.
Keep learning and trade wisely,
Market Wealth Daily