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Protecting Principal With Volatility ETFs, Inverse ETFs And Long-Short ETFs

09 August 2011 at 9:34 am by Staff     Bookmark and Share    Follow EtfExpert on Twitter

There are a wide variety of active risk management strategies. None of them are fool-proof.

The one that we advocate — stop-limit loss orders — may have adverse tax consequences; the stop may also fail to execute in a rapidly declining market.

Options and futures investors cheer the “out-of-the-money” puts. This has the benefit of an insurance policy, though it may feel like wasted money if a calamity doesn’t occur. Moreover, if a put order is only placed on SPDR S&P 500 (SPY), you may not be protecting a well-diversified portfolio with lower-correlating assets.

Inverse ETFs are popular with traders. Yet there’s an incredibly poor understanding of daily compounding versus annual compounding. For instance, iShares DJ Real Estate (IYR) fell -40% in 2008. Many who chose ProShares UltraShort Real Estate (SRS) believed that the 2x-the-inverse-fund should have garnered them 80% for being on the right side of the trade. Being on the proper side of the real estate trade with SRS resulted in a loss of -50% — not a gain of 80% — due the differences between daily and annual compounding.

There are other alternatives as well… and the idea has been picking up steam. There are a number of folks who invest in volatility, which tends to spike dramatically in major league sell-offs. The gains can go a long way to protecting a chunk of one’s principal. Yet even these relatively new tools have their drawbacks as well.

Volatility ETFs: The Real Safe Haven?– Jared Cummans, ETFdb
Bear Roars For SPY– Benzinga
Other Bond ETFs Lag Treasuries; BAB A Buy – Murray Coleman, Barron’s   
ETF Spotlight: United States Commodity Index– Abraham Bailin, Morningstar
Avoid Racing For The Sidelines: Spread Out Risk, Disregard Emotional Swings– Kevin Prendergast, Seeking Alpha  


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Disclosure Statement: ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships. You may review additional ETF Expert disclosure details here.

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