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How to Short Financial Sector With ETFs

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The recent stock market rout has resulted in sluggish trading in most of the sectors with financials being the worst hit. The S&P 500 Financial Sector Index is down 6% so far this month, underperforming the broader S&P 500 Index, which shed 3.3%.

The big drop came on the back of increasing trade tensions, recessionary fears and rising geopolitical tension that pushed the yields down. Additionally, bouts of negative news including the unrest in the Asian financial hub of Hong Kong and downbeat economic data across the globe has worsened the global outlook, raising speculation for another cut in September.

Notably, the 10-year Treasury yields dropped to 1.640%, marking its lowest level since Oct 2016 while 2-year Treasury yields fell to 1.578%. Several strategists expect the 10-year yield to fall below the 2-year note yield, flashing warning about a recession (read: Treasury ETFs Rally to New Highs on New Tariff Threats).

Financial sector, especially banks are at  risk in such a situation. This is because banks borrow money at short-term rates and lend at long-term rates. If long-term interest rates fall more than the short-term ones, banks earn less on lending and pay more on deposits, leading to a tighter spread. This restricts net margins and puts pressure on their profits. The situation has also raised worries about the health of banks and increased chances of default.

Moreover, all 24 stocks in KBW Bank Index have slumped so far this month on concern that lower interest rates will squeeze profits. Per Bloomberg, traders have yanked more than $1.5 billion from all U.S.-listed exchange-traded funds tracking the financial sector in the week through Aug 8, the fastest pace this year. The ultra-popular Financial Select Sector SPDR Fund (XLF - Free Report) , with an asset base of around $21.9 billion and average daily volume of around 49 million shares, has seen eight straight days of outflows, totaling close to $3 billion. According to data compiled by etf.com, XLF has pulled out $2.3 billion so far this month (read: Financial ETFs Caught Between Solid Earnings & Falling Yields).

Given the massive outflow and the bearish outlook, the appeal for financial ETFs, especially banks, has dulled. As a result, investors who are bearish on the sector right now may want to consider a near-term short. Fortunately, with ETFs, this is quite easy as there are many options to accomplish this task. Below we highlight them and state how each stands out among the rest.

ProShares Short Financials ETF (SEF - Free Report)

This fund provides inverse (or opposite) exposure to the daily performance of the Dow Jones U.S. Financials Index. The ETF makes a profit when financial stocks decline and is suitable for hedging purposes against fall of these stocks. The product has amassed $19.7 million in AUM while volume is light around 17,000 shares. Expense ratio comes in at 0.95%. The product has added 3.5% over the past month.

ProShares UltraShort Financials ETF (SKF - Free Report)

This fund seeks two times (2x) leveraged inverse exposure to the Dow Jones U.S. Financials Index, charging 95 bps in fees. It has amassed $24.9 million in its asset base and trades in lower volume of around 39,000 shares per day on average. SKF has returned about 7.1% in the same timeframe.

ProShares UltraPro Short Financial Select Sector ETF (FINZ - Free Report)

Investors having a more bearish view and a higher risk appetite may find FINZ interesting as the fund provides three times (3x) inverse exposure to the S&P Financial Select Sector Index. It charges 95 bps per year while the average daily trading volume is paltry at 9,000 shares. It has accumulated $1.3 million in AUM and gained nearly 15.4% in a month.

Direxion Daily Financial Bear 3x Shares ETF (FAZ - Free Report)

This product provides three times inverse exposure to the Russell 1000 Financial Services Index. Though it charges the same annual fee of 95 bps, it is extremely popular with AUM of $157.9 million and trades in heavy volume of around 514,000 shares. The fund has gained 11.1% in the same timeframe.

Direxion Daily Regional Banks Bear 3x Shares (WDRW - Free Report)

This fund seeks to deliver thrice the inverse return of the S&P Regional Banks Select Industry Index, charging 95 bps in fees per year. WDRW has accumulated $1.5 million in its asset base and trades in paltry volume of around 6,000 shares a day on average. The fund is up 14.2% over the past month (read: 5 Leveraged Inverse ETFs That Soared More Than 40% in May).

MicroSectors U.S. Big Banks Index Inverse ETN (KNAB - Free Report)

This is an ETN option providing inverse exposure to the Solactive MicroSectors U.S. Big Banks Index, an equal-dollar weighted index that seeks to provide exposure to the 10 largest U.S. banks and financial services companies. It has accumulated $24.7 million in its asset base and charges 95 bps in annual fees. The note trades in average daily volume of under 1,000 shares and has added 6.1% in a month.

MicroSectors U.S. Big Banks Index -2X Inverse Leveraged ETN (BNKZ - Free Report)

With AUM of $24.1 million, this ETN provides two times exposure to the Solactive MicroSectors U.S. Big Banks Index. It charges 95 bps in annual fees and trades in average daily volume of under 1,000 shares. BNKD is up 11.8% in a month.

MicroSectors U.S. Big Banks Index -3X Inverse Leveraged ETN (BNKD - Free Report)

BNKD seeks to offer three times exposure to the Solactive MicroSectors U.S. Big Banks Index. The ETN has accumulated $23.2 million in its asset base. It charges 95 bps in annual fees and trades in average daily volume of about 1,000 shares. BNKD is up 17.6% in a month (read: Markets Bleeding: Go Short With These ETFs).

Bottom Line

As a caveat, investors should note that such products are suitable only for short-term traders as these are rebalanced on a daily basis.

Still, for ETF investors who are bearish on the financial sector for the near term, either of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is the friend” in this corner of the investing world.

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