# Understanding Inverse ETFs: Differences from Short Selling & Key Insights

![A man checks trading positions on his cell phone, with a laptop displaying a stock chart in the background](https://www.investopedia.com/thmb/g_HsUE2frbdopxuRVqcX0J5DKp8=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-14712990721-171e3a6ece3c43f6b796978b11c0d733.jpg)

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Inverse ETFs are designed to profit from market declines by using derivatives, offering investors an alternative to traditional short selling. Unlike direct shorting, these funds do not require margin accounts and entail specific risks and management costs for investors, making them more suitable for short-term strategic trades.

An inverse ETF is also known as a "Short ETF" or "[Bear ETF.](https://www.investopedia.com/3-inverse-sector-etfs-market-bears-4570836)"

### Key Takeaways

*   Inverse ETFs are financial instruments designed to profit from market declines by using derivatives like futures and options.
*   Unlike traditional short selling, inverse ETFs do not require a margin account, making them more accessible to retail investors.
*   Inverse ETFs are intended for short-term use since they reset daily, which can lead to divergence from the intended inverse performance over longer periods.
*   Investors should be aware of the higher management fees associated with inverse ETFs compared to traditional ETFs.
*   Leveraged inverse ETFs aim to provide amplified returns by using derivatives and debt to magnify the inverse movement of an underlying index.

## How Inverse ETFs Function

Many inverse [ETFs](https://www.investopedia.com/terms/e/etf.asp) use daily futures contracts for returns. A [futures contract](https://www.investopedia.com/terms/f/futurescontract.asp) is a contract to buy or sell an asset or security at a set time and price. Futures allow investors to bet on the direction of a securities price.

Inverse ETFs use [derivatives](https://www.investopedia.com/terms/d/derivative.asp) like futures to bet on market declines. If the market falls, the inverse ETF rises by roughly the same percentage minus fees and commissions from the broker.

Inverse ETFs are not long-term investments since the derivative contracts are bought and sold daily by the fund's manager. Thus, inverse ETFs may not match the long-term performance of the tracked index or stocks. Frequent trading often increases fund expenses, and some inverse ETFs can carry [expense ratios](https://www.investopedia.com/terms/e/expenseratio.asp) of 1% or more.

Pros

*   Inverse ETFs allow investors to make money when the market or the underlying index declines.
    
*   Inverse ETFs can help investors hedge their investment portfolio.
    
*   There are multiple inverse ETFs for many of the major market indices.
    

Cons

*   Inverse ETFs can lead to losses quickly if investors bet wrong on the market's direction.
    
*   Inverse ETFs held for more than one day can lead to losses.
    
*   Higher fees exist with inverse ETFs versus traditional ETFs.
    

## Inverse ETFs Compared to Short Selling

Inverse ETFs don’t need a [margin account](https://www.investopedia.com/terms/m/marginaccount.asp), unlike [short positions](https://www.investopedia.com/terms/s/short.asp). A margin account is one where a broker lends money to an investor to trade. [Margin is used with shorting](https://www.investopedia.com/articles/investing/060314/guide-buying-etfs-margin.asp), an advanced trading activity.

Investors who enter into short positions borrow the securities—they don't own them—so that they can sell them to other traders. The goal is to buy the asset back at a lower price and unwind the trade by returning the shares to the margin lender. But there's a risk the security's value rises, forcing a buyback at a higher price.

In addition to a margin account, [short selling an ETF](https://www.investopedia.com/ask/answers/163.asp) requires a [stock loan fee](https://www.investopedia.com/terms/s/stock-loan-fee.asp) paid to a broker for borrowing the shares necessary to sell short. High [short interest](https://www.investopedia.com/terms/s/shortinterest.asp) can make shares hard to find and increase short selling costs. In many cases, the cost of borrowing shares to short can exceed 3% of the borrowed amount, which is why inexperienced traders can quickly get in over their heads.

Inverse ETFs often have expense ratios under 2% and are available to anyone with a brokerage account. Despite the expense ratios, it is still easier and less costly for an investor to [take a position in an inverse ETF](https://www.investopedia.com/articles/mutualfund/07/inverse-etfs.asp) than to sell individual stocks short.

## Exploring Different Types of Inverse ETFs

There are several inverse ETFs that can be used to profit from declines in broad market indexes, such as the [Russell 2000](https://www.investopedia.com/terms/r/russell2000.asp) or the [Nasdaq 100](https://www.investopedia.com/terms/n/nasdaq100.asp). There are also inverse ETFs that focus on specific sectors, such as financials, energy, or consumer staples.

Some investors use inverse ETFs to profit from market declines, while others [hedge their portfolios](https://www.investopedia.com/terms/h/hedge.asp) against falling prices. For instance, S&P 500 ETF owners can hedge by buying an inverse ETF for the S&P 500. However, hedging has risks as well. If the S&P rises, investors might have to sell their inverse ETFs since they will incur losses that could offset any gains in their original S&P investment.

Inverse ETFs are short-term trading instruments that must be timed perfectly for investors to make money. There's a significant [risk of losses](https://www.investopedia.com/articles/investing/092815/risks-investing-inverse-etfs.asp) if investors allocate too much money to inverse ETFs and time their entry and exit poorly.

## Understanding Double and Triple Inverse ETFs

A [leveraged ETF](https://www.investopedia.com/terms/l/leveraged-etf.asp) is a fund that uses derivatives and debt to magnify the returns of an underlying index. Typically, an ETF's price rises or falls on a one-to-one basis compared to the index it tracks. A leveraged ETF is designed to boost the returns to 2:1 or 3:1 compared to the index.

Leveraged inverse ETFs use the same concept as leveraged products and aim to deliver a magnified return when the market is falling. For example, if the S&P has declined by 2% in a day, a 2X-leveraged inverse ETF will deliver a 4% positive daily return to the investor excluding fees and commissions.

## Practical Example of an Inverse ETF in Action

ProShares Short S&P 500 ([SH](https://www.investopedia.com/markets/quote?tvwidgetsymbol=sh)) provides inverse exposure to large and midsize companies in the S&P 500. It had an expense ratio of 0.88% and about $1.93 billion in net assets as of Q4 2023. The inverse ETF aims to provide a one-day trading bet and is not designed to be held for more than one day.

On Nov. 2, 2023, the S&P rose 1.07%, and as a result, shares of SH fell 1.07% in turn, from $14.88 to $14.72. If investors had been invested in the SH during that up day in the market, they would have realized losses.

## How Do Inverse ETFs Work?

Inverse ETFs use various derivatives like futures, swaps, and options contracts to take short positions in the underlying index. They also rebalance daily to maintain the inverse relationship as markets move each trading day.

## Why Would Traders Buy Inverse ETFs?

Traders may use inverse ETFs to profit from or hedge against declines in a specific market. Short-term traders may also use them to speculate on downward moves.

## Why Are Inverse ETFs Only Intended for Short Holding Periods?

Since they rebalance daily, inverse ETFs often diverge from the actual inverse performance over longer periods. They also compound losses in volatile, upward-trending markets. Indeed, inverse ETFs tend to decline in value over time regardless of whether the underlying market is rising or falling. Because of this, inverse ETFs are complex products meant for active traders, not long-term buy-and-hold investments.

## Summary: Key Insights on Inverse ETFs

Inverse ETFs provide an opportunity for investors to profit from or hedge against market declines by moving opposite to a benchmark index on a daily basis, using derivatives like futures and options. These financial instruments are suited for short-term strategies and are not recommended for long-term investment due to their daily reset mechanism that can result in divergence from the market’s actual inverse performance over time.

The daily rebalancing can amplify losses, especially in [volatile](https://www.investopedia.com/terms/v/volatility.asp) or upward-trending markets, increasing potential risks. Therefore, inverse ETFs are more appropriate for experienced, active traders rather than the average retail investor, who may not be prepared for the complexities and risks involved.  
  

> **Article Sources**
>
> 1.  Financial Industry Regulatory Authority. "[The Lowdown on Leveraged and Inverse Exchange-Traded Products](https://www.finra.org/investors/insights/lowdown-leveraged-and-inverse-exchange-traded-products)."
>     
> 2.  VettaFi. "[Inverse ETF List: ETF Expenses](https://etfdb.com/etfs/inverse/#etfs__expenses&sort_name=expense_ratio&sort_order=desc&page=1)."
>     
> 3.  Financial Industry Regulatory Authority. "[Brokerage Accounts: Overview](https://www.finra.org/investors/investing/investment-accounts/brokerage-accounts#overview)."
>     
> 4.  ETF.com. "[SH](https://www.etf.com/SH)."
>     
> 5.  YCharts. "[ProShares Short S&P500 (SH)](https://ycharts.com/companies/SH)."