There are a wide range of Leveraged Short/UltraShort ETFs (FAZ, ERY, BGZ, etc.) that average individual investors can use to protect against a stock market correction.

These Exchange Traded Funds (ETFs) are structured to move inversely to the market as a whole or to specific market sectors. As such, they perform well (go up in value) when markets are on a decline and do very poorly when stocks are rising. Leveraged ETFs are available for most indexes (Dow, Nasdaq, S&P, Russell, etc.) and for a broad range of sectors: Financial, Technology, Small Caps, Large Caps, Health Care, Real Estate, etc. 

How They Work

For our explanation of how defensive ETFs work, let us assume you own banking shares (e.g. Bank of America shares) and also purchased one of the various Financial Services Defensive ETFs available.

  • Short ETFs (1x): Short ETFs are structured to move in an inverse 1:1 relationship with their underlying index or sector. So if your Bank of America shares drop by 1% during the day, then the Financial Services Defensive ETF would be expected to move up 1%.
  • UltraShort ETFs (2x): Ultra Short ETFs are structured to move in an inverse 2:1 relationship. So if the bank stocks you have in your portfolio go down 1% during the day, then the UltraShort Financials ETF (2x) will be expected to move up 2%.
  • UltraShort ETFs (3x): 3:1 relationship. If your bank stocks decline 1%, then the UltraShort Financials ETF (3x) should go up 3% during the day.

It is very important however to understand that leverage ETFs are structured for daily movements. As best stated by Direxion Funds (fund manager of the widely followed Direxion 3X ETFs):

“our leveraged 3X Defensive ETFs seek a return that is 3 times the return of its benchmark index for a single day. The fund should not be expected to provide three times the return of the benchmark’s cumulative return for periods greater than a day”.

In other words, if you plan to hold the Daily Financial Bear 3x ETF (FAZ) for longer than one day, then you might not get the exact 3:1 relationship. It could be higher or lower than 3:1 as can be seen in the diagram below.

Chart – Bank of America vs. Direxion 3X ETF

This is a 6-month chart between Bank of America (BAC) stock versus the Daily Financial Bear 3x ETF (FAZ). If you had both securities in your portfolio over the last 6 months, then you would have seen your BAC stocks increase by 48%, while your FAZ holdings would only have dropped 42%. 

If BAC had dropped 48% over this 6 months period, then your FAZ holdings would have gone up by 42% or more – defensive ETFs are designed to go up faster than they go down. Over this 6-month period of time, we see that this 3:1 defensive ETF (FAZ) acted like a 1:1 defensive ETF – the point is that they are designed to be used as trading tools (in and out) not as long term buy and hold instruments.

BAC Stock & FAZ ETF Chart
August 8th 2012 to February 7th, 2013

Chart Source: Yahoo! Finance

Overall, the highly leveraged ETFs are meant to be used only on a short term basis for hedging your stock holdings. To protect against a short term market correction, they have proven to be effective defensive products – but don’t hold them forever.

Profit Making Approach

In addition to using these instruments for hedging purposes, they can also be used for profit making strategies. For example, even if you don’t have any banking stocks, you can still buy the FAZ Defensive ETF if you believe the market or the banking sector in particular will drop in value.

If you are right and bank stocks/banking sector do indeed decline in value for some reason (e.g., higher regulations, lower profit margins, etc.), then your FAZ ETF will soar in value and you can cash out with a big profit.

List of Leveraged ETFs

Below are some hedging ETFs that investors can invest in during or before a market correction – depending on your risk appetite and level. However, please note that with these leveraged financial instruments, you can make a “boatload” of money in a very short period or get taken to the cleaners. MarketConsensus strongly recommends that you consult with an independent financial advisor regarding your investing choices.

7 Highly Leveraged Defensive ETFs (3x)

ETF Name Ticker Benchmark Index
Daily Large Cap Bear 3x BGZ Russell 1000
Daily Mid Cap Bear 3x MWN Russell Midcap Index
Daily Small Cap Bear 3x RTY Russell 2000
Daily Energy Bear 3x ERY Russell 1000 Energy
Daily Financial Bear 3x FAZ Russell 1000 Financial Services
Daily Technology Bear 3x TYP Russell 1000 Technology
Daily Real Estate Bear 3x DRV MSCI US REIT Index

7 Leveraged Defensive ETFs (2x)

ETF Name Ticker Benchmark Index
UltraShort Basic Materials SMN Dow Jones U.S. Basic Materials
UltraShort Financials SKF Dow Jones U.S. Financials
UltraShort Industrials SIJ Dow Jones U.S. Industrials
UltraShort Real Estate SRS Dow Jones U.S. Real Estate
UltraShort Semiconductors SSG Dow Jones U.S. Semiconductors
UltraShort Oil & Gas DUG Dow Jones U.S. Oil & Gas
UltraShort Technology REW Dow Jones U.S. Technology

5 Short ETFs (1x)

ETF Name Ticker Benchmark Index
Short QQQ PSQ Nasdaq-100
Short Dow 30 DOG DJIA
Short S&P 500 SH S&P 500
Short Mid Cap 400 MYY S&P Mid Cap 400
Short Small Cap 600 SBB S&P Small Cap 600
Short Russell 2000 RWM Russell 2000

Gold and Silver ETFs / ETNs

ETF Name Ticker Risk Level
ProShares Ultra (2x) Silver AGQ mid to high risk appetites
ProShares UltraShort Silver ZSL mid to high risk appetites
ProShares Ultra Gold UGL mid to high risk appetites
ProShares UltraShort Gold GLL mid to high risk appetites
DB Gold Short ETN DGZ Lower level of risk
DB Gold Double Short ETN DZZ mid to high risk appetites