The amazing diversity of ETFs allow investors to kill one bird with two stones.
Consider iShares Nasdaq Biotechnology (IBB), the largest exchange traded fund in its segment. IBB debuted on IBD Leaderboard March 9, making it the first ETF to be added as a short-sale idea. Shorting the ETF would allow investors to profit if its holdings continue to decline.
The $6.04 billion exchange traded fund’s downward-sloping relative strength line reflects the weakness found in the charts of most major biotechs.
Investors can also use ProShares UltraShort Nasdaq Biotech (BIS) to achieve the same goal. It’s an ETF leader in the current market with a Relative Strength Rating of 98. That means its recent price performance is in the top two percentile of all stocks and ETFs tracked by IBD.
BIS seeks daily investment results that correspond to two times the inverse (-2x) of the daily performance of the Nasdaq Biotechnology Index.
An ETF investor might legitimately ask: Is it better to short the largest biotech ETF or to take a long position in its inverse counterpart?
The inverse ETF is probably best left alone by all except sophisticated ETF investors and day traders.
“If an investor is looking for dollar-for-dollar gain for falling ETF price, then it would be appropriate to short the specific ETF,” Monish Shah, head of ETF trading at Mizuho Securities, recently told IBD. “For instance, if you short 1,000 shares of a particular ETF and then the price drops by $1, your unrealized profit would be $1,000. However, the major risk of short selling is that while the profit is capped, risk is unlimited. Because in a short position, the ETF price could rise indefinitely, and this would force the investor to cover at a higher price.”
With an inverse ETF, the loss is capped, i.e. the amount you have invested. But inverse ETFs may bring risks or challenges for the average investor.
“It is critical to understand that an inverse return on the underlying index is expected to match only on a daily basis,” Shah added, “but over a longer term, a significant disconnect will likely arise between the return on an inverse ETF and the return on its underlying index due to the compounding effect.”
Both types of investing strategies have the potential to amp up your portfolio returns in a restrained investing climate. However, they require more molly-coddling to ensure any losses don’t run away from you. That will be key to successful investing.
How’s the overall picture for IBB and other biotech ETFs?
The major holdings of IBB include Celgene (CELG), Biogen (BIIB) and Gilead Sciences (GILD).
“While those stocks are in deep corrections, the industry fundamentals aren’t so bad,” according to the IBD markets team. “The heath care sector has the best EPS and sales growth estimates for 2016, and analyst revisions in biotech are the best for any part of the sector. Drug pipelines remain well-stocked. Plus, licensing deals remain hot. But no question, sales growth has slowed sharply from a 2014 peak.”
IBB was falling 3% on the stock market today, while BIS added 6% intraday.
Year to date, IBB plunged 23% through March 14. It saw $295.3 million in net outflow over the first two months of the year.
By comparison, BIS is up 53% over the same period and leaked $15.4 million.
View more information: https://www.investors.com/etfs-and-funds/etfs/better-to-short-biotech-etf-or-to-invest-in-inverse-counterpart/