Trading Short ETFs
On May 5th, 2022, tech-heavy Nasdaq 100 index tumbled 5% in a single day. That day, investors holding short ETFs tracking the index earned a profit while those holding long ETFs tracking the index suffered a loss.
What are short ETFs?
In trading stocks, if you expect a stock to gain value, you buy the stock. If you expect it to lose value, you short it.
ETFs work in a similar way. There are two types of ETFs, short (bear) and long (bull) ETFs. If you think the index will go up, you can buy long ETFs. In contrast, if you think the index will drop, you can buy short ETFs. You don’t need a margin account to short any ETFs.
Short ETFs hold derivatives—for example, swaps and futures—to achieve the opposite of the index returns.
How do short ETFs work?
Let’s look at an example to see how short ETFs work.
Over the first half of 2022, the Nasdaq 100 index (NDX) tumbled about 29%. Below, we see that ETF 1 tracking -100% of NDX gained almost 30%. ETF 2 tracking -300% of NDX gained 84%.
So, basically, the price of a short ETF goes in the opposite direction of the index it tracks.
How are short ETFs different from shorting stocks?
The concept of short ETFs and shorting stocks have many similarities. In both cases, investors expect the price to go down.
In practice, they do have their differences. With ETFs, buying short and long ETFs are the same in operation. You only need to hit the “buy” button. However, with shorting stocks, you’ll need a margin account.
The risks are also different. If you buy short ETFs, the maximum loss you could suffer is the principal you invested. However, if you short a stock, you need to buy back the stock at a later date. Since the stock price is not certain, your losses are uncapped.
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