Using ETF Index Shares to Hedge Stock Market Risk Exposures

Investments typically involve risk. Many investors wish to manage some of that risk in their investment portfolios, and financial markets offer a variety of mechanisms for doing this, for many types of risk. One effective hedging mechanism is particularly attractive to retail investors: ETF shares that return the inverse of a stock market index. This article explains how these “inverse index ETFs” (ILETFs) shares can be used to hedge market risk exposures in a cost-effective way. After discussing some basic hedging strategies, we explain how ILETFs can be used for multiday hedging even though their daily targeted return multiple gives them an unpredictable return over holding periods longer than one day. In an effort to make the text accessible to as many readers as possible, much of the underlying is confined to the <xref>Appendix</xref>.