How to Outperform the Market and Manage Risk With ETFs
01/11/08 - 04:42 PM EST
Scott Rothbort
How to Use ETFs for Hedging and Risk Management
Traditionally, hedging
requires the use of more sophisticated techniques, such as short-selling, futures or options. These activities take place in commodity or margin accounts . Because of securities and credit regulations, not all investors and investment accounts can transact in these ways. This includes IRAs , which do not have access to short selling or put buying. However, all is not lost; individual investors now have a range of ETFs to fill this void.
As the ETF industry continues to evolve, a vast array of investment products have been developed to suit the hedging needs of all types of investors in all types of accounts.
Let's look at the S&P 500 Index (SPX Quote - Cramer on SPX - Stock Picks) as an example. The basis ETF for the S&P 500 is the S&P 500 Depository Receipt (SPY Quote - Cramer on SPY - Stock Picks), also commonly referred to as the "Spyder" (or "SPDR"). This S&P 500 ETF is a trust that tracks the S&P 500 Index (with some minor subtraction for fees and expenses). Thus, if you want exposure to all 500 companies in the S&P, then buying the S&P 500 Depository Receipt is an effective way to do it.
On the other hand, if you want to short the S&P or hedge S&P risk, you can do so by shorting the Spyder. However, as I mentioned before, if you are trading in a cash account, then this provides no help in terms of risk management. Thus, an inverse ETF was created, the ProShares Short S&P 500 (SH Quote - Cramer on SH - Stock Picks), which provides a negative relationship to the S&P.
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