Thanks to the explosion of
How to Use ETFs for Rapid Asset ReallocationIn past lessons, I have discussed the need to
Step 2A. Use an ETF as a placeholder for the asset allocation. In this case we would select the Market Vectors Global Agribusiness ETF ( MOO). Step 2B. Now we have the luxury of time to perform due diligence and select a stock that represents the best opportunity in the sector for long term appreciation, without losing exposure to that sector as we perform this research.
How to Use ETFs for Hedging and Risk ManagementTraditionally,
How I Manage Risk With ETFsHere is one risk management method which I have employed in the past and plan to use again. Say you are 100% long in your account. You want to move to a more neutral position. Take the following actions:
1. Sell 30% of your portfolio. When I say 30% I do not mean 30% of theFor quick reference, below is a table which lays out the ETFs in various forms for the major U.S. indices:
market value. I mean 30% of the betavalue of the portfolio (see " The Finance Professor: Manage Risk Like a Pro"). You can achieve this by selling 30% of each position or carefully vetting out individual positions to arrive at this goal. You should now have a portfolio that is 70% invested and 30% in cash. 2. With the sale proceeds, buy the UltraShort S&P500 ETF. By using 30% of your risk capitalto buy the "ultra-short" ETF, you have now created twice that amount (60%) in downside exposure. You should now have a portfolio that is only 10% exposed to the market. Please note: the exposure may vary by portfolio due to individual beta calculations and tracking errors. A tracking error is the difference between the actual performance of a portfolio and the benchmark index which it is designed to imitate. 3. Monitor the market. Once the market has corrected, you can sell your ultrashort hedge and redeploy your capital back into the market.
| ||Corresponding ETF|
|Long||Long Levered||Short||Short Levered|
|S&P 500 (SPX)||SPDR Trust (SPY)||Ultra S&P 500 (SSO)||Short S&P500 (SH)||UltraShort S&P500 (SDS)|
|Russell 2000 (RUT)||iShares Russell 2000 (IWM)||Ultra Russell 2000 (UWM)||Short Russell2000 (RWM)||UltraShort Russell2000 (TWM)|
|S&P 400 MidCap (MID)||MidCap SPDRs (MDY)||Ultra MidCap 400 (MVV)||Short MidCap400 (MYY)||UltraShort MidCap400 (MZZ)|
|NASDAQ 100 (NDX)||PowerShares QQQ (QQQQ)||Ultra QQQ (QLD)||Short QQQ (PSQ)||UltraShort QQQ (QID)|
|Dow Jones Industrial (DJI)||?DIAMONDS? Trust (DIA)||Ultra Dow30 (DDM)||Short Dow30 (DOG)||UltraShort Dow30 (DXD)|
|S&P 600 SmallCap (SML)||iShares S&P SmallCap 600 Index (IJR)||Ultra S&P SmallCap600 (SAA)||Short S&P SmallCap600 (SBB)||UltraShort S&P SmallCap600 (SDD)|
ETFs have a variety of uses and come in many different forms. This lesson outlined two interesting ways you can use ETFs as part of your risk management and overall investment process. In the future, I will present other techniques for managing your portfolio with ETFs. In the meantime, if you are looking to reallocate a portion of your assets or go to a more neutral market stance, consider using the strategies I outlined above.