These funds work by using short selling, trading derivatives such as futures contracts, and other leveraged investment techniques.
By providing over short investing horizons and excluding the impact of fees and other costs, performance opposite to their benchmark, inverse ETFs give a result similar to short selling the stocks in the index.
An inverse ETF, on the other hand, provides many of the same benefits as shorting, yet it exposes an investor only to the loss of the purchase price.
Some have claimed that this trading causes increased volatility (Cheng & Madhavan 2009), while others argue that the activity is not significant.
In 2015 the three U.S. listing exchanges—the New York Stock Exchange, NASDAQ and BATS Global Markets—resolved to cease accepting stop-loss orders on any traded securities.
In a market with a long-term upward bias, profit-making opportunities via inverse funds are limited in long time spans.
[3] In addition, a flat or rising market means these funds might struggle to make money.
Inverse ETFs are designed to be used for relatively short-term investing as part of a market timing strategy.
Compared to a short position with identical initial exposure, the inverse ETF will therefore usually deliver inferior returns.
Such large declines benefit the inverse ETF because the relative exposure of the short position drops as the market fall.
In that case an inverse ETF will always incur a volatility loss relative to the short position.
[6] An investor in an inverse ETF may correctly predict the collapse of an asset and still suffer heavy losses.
This particular scenario requires both abrupt and profound volatility – by contrast, the S&P 500 index has never increased by more than 12% in one day.
For instance, between the close of November 28, 2008 and December 5, 2008, the iShares Dow Jones US Financial (NYSE: IYF) moved from 44.98 to 45.35 (essentially flat, properly an increase of 0.8%), so a double short would have lost 1.6% over that time.
However, it varied greatly during the week (dropping to a low of 37.92 on December 1, a daily drop of 15.7%, before recovering over the week), and thus the ProShares UltraShort Financials (NYSE: SKF), which is a double-short ETF of the IYF moved from 135.05 to 117.18, a loss of 13.2%.
is the variance of the index process and the last term on the right hand side constitutes the volatility gain.
[8]: 394 Some inverse ETFs are: AdvisorShares BetaShares Exchange-Traded Funds Boost ETP Direxion ProShares Horizons BetaPro Tuttle