The market recently underwent a correction of about 10%, and it’s during these periods that investors get a learning opportunity.
You get to find out how you felt during the correction. Was your stomach turning the day the Dow Jones Industrial Average fell 330-plus points before recovering? Did you wish you had a market hedge in place?
Risk tolerance is something most investors overestimate. They think they can emotionally and psychologically handle larger market corrections than they actually can. As a result, many investors end up selling toward the end of a correction, when the market is near a bottom. Then they lose out as the market recovers.
Since ETFs exploded onto the investment scene, it is easier than ever to open up a market hedge at any time, and in a matter of seconds.
In the old days, the best you could do was to short a stock or buy tons of put options. Shorting, however, had to be on a uptick, which wouldn’t happen much during a correction. But ETFs give you that instantaneous ability to hedge your portfolio if you have cash or margin available, and to do so without selling out on long holdings.
The simplest and most obvious move is to buy the ProShares Short S&P 500 (SH), which does just as it says — you short S&P 500 index. Most investors are long the same index, so by buying an equal amount of this ETF to balance out your long position, you’ll become “market neutral.”
I like the market neutral position because it just means you are sitting on the sidelines. You aren’t losing or gaining anything, and you may not have to deal with constructive short sale rules (shorting against the box), which can be complex.
Of course, if you really feel we are in the midst of a significant correction or crash, you can purchase more of this ETF than you hold on the long side and earn money on the downside. SH costs 0.89% in expenses, or $89 for every $10,000 invested.
Another choice is the ProShares Short QQQ (PSQ), which allows you take a short position in the Nasdaq-100. During a correction, tech stocks tend to get hit harder. The Nasdaq-100 tends to have high volatility and offers a good way to make money on the way down. If, for example, you have a neutral position on the S&P 500, having a short position on the Nasdaq-100 is where you may make some money during the correction. PSQ charges 0.95%.
You also can use leverage on this play, by buying the ProShares UltraShort QQQ (QID), which gives you a double short position on the Nasdaq-100. QID, like PSQ, charges 0.95%.
If you want to go with an even broader short position, consider the ProShares Short Russell 2000 (RWM); small-cap stocks tend to get hit hard, particularly in crashes, so the RWM is a good way to play that. You also can buy the relatively illiquid ProShares Short Small Cap 600 (SBB); both charge 0.95%.
Lastly, if emerging-market stocks are swooning and you want a market hedge for the rest of the world, you can try the ProShares Short MSCI Emerging Markets (EUM), which was a great play earlier this year. Like most of this lot, EUM charges 0.95%.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets at @ichabodscranium.