How to Cover Your Behind If the S&P 500 Comes Unhinged (SH, SDS, SPXU)

Hedge your long-term bets, or get active on the bear side

It’s not a bad time to be a fear-monger right now.

While the S&P 500 still sits near all-time highs, and has even reset the high bar as recently as last month, there are a number of reasons to believe it’s all going to bunk soon.

On a fundamental level, U.S. stocks could easily drop from their perch with the pull of a trigger. If Greece finally fails to keep itself in the eurozone, there’s the potential for a big burp out of Europe to hit global stocks broadly. A pop in the increasingly bubbly Chinese stock market wouldn’t do much to encourage investors, either.

And technically speaking, you’ve got the same thing brewing at home — the S&P 500 just seems to be waiting for a reason to dive.

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For the past couple of months, the S&P 500 has repeatedly fought with its 20- and 50-day moving averages, and while the latter has held for support, that support weakens with every challenge.

This is coming at the same time in which the S&P 500 is trading in an increasingly tightening range, begging for an opportunity to break out — one way or the other.

None of this is to say that a crash is imminent, that all is lost and that those caught with any exposure to stocks will be severely punished. But it is saying that a little caution might be warranted.

If you think you could use just a little bit of protection, or if you’re strongly in the bear camp and think now’s the time to strike, there’s a particular set of funds you should get familiar with in the coming days.

Portfolio Protection — ProShares Short S&P500 (SH)

The ProShares Short S&P500 (SH) is one of the simplest hedges on the market. This fund essentially seeks to return the opposite of the S&P 500 on a daily basis — meaning that when the S&P 500 goes up, the SH ETF should fall by the opposite amount, and vice versa.

The idea behind this? If you’re long several stocks, you could protect your money by selling your positions … but is it worth it to rack up a bunch of transaction fees to lock in profits, then rack up even more when you buy back into your positions? I’d say it isn’t.

Instead, SH merely allows you to claw back some of the losses you’d likely incur across a broader-market decline (even if you’re not long the whole S&P 500).

One note: The SH ETF isn’t a pure short fund — that is to say, rather than simply holding nothing but SPDR S&P 500 ETF (SPY) short positions, or going long individual holdings like Apple (AAPL) and Exxon Mobil (XOM), SH uses credit swaps and e-mini futures to “create” its returns.

Still, SH is a fairly “safe” hedge in that it’s not leveraged; 2x and 3x funds can deliver outsized returns, but also outsized pain. I’m actually considering this fund currently as a hedge for my own portfolio.

Also, SH charges just 0.89%, or $89 annually for every $10,000 invested, in expenses. Sure, that’s not cheap by normal index fund standards, but given its unique function, you’re not being raked over the coals for it.

Join the Bears on the Hunt — ProShares UltraShort S&P 500 (SDS) and ProShares UltraPro Short S&P 500 (SPXU)

Whereas the SH is very much a protective hedge play, the ProShares UltraShort S&P 500 (SDS) and ProShares UltraPro Short S&P 500 (SPXU) are attack-first strategies for traders who think the market’s fun is done.

SDS is designed to provide two times the inverse of the S&P 500’s performance on a daily basis, while the SPXU is designed to provide 3x the inverse. The former charges 0.89%, while the latter charges 0.92%.

I recently discussed the appropriate time to go with leveraged funds, but the “proper time” is ultimately at your discretion. Still, it’s important to understand a particular aspect of leveraged funds: While they return 2x or 3x the returns of an index (or the inverse), that’s on a daily basis — over time, their performance can start to look nothing like what you’d expect.

Investopedia provides some helpful example math here — in bad-case scenarios, you theoretically could see less in gains to the upside than you’d expect, or even more losses to the downside.

Investors have little business piling too much money into either of these products; SDS and SPXU should be made for small, tactical trades.

Naturally, because losses can pile up very quickly in these funds, have an exit strategy mapped out (including stop-losses) should the market not cooperate and grudgingly keep pushing higher.

Kyle Woodley is the Managing Editor of InvestorPlace.com. As of this writing, he was considering opening a position in SH within the next 48 hours. Follow him on Twitter at @KyleWoodley.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/06/sp-500-hedges-sh-sds-spxu/.

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