The versatility of exchange-traded funds (ETFs) appe🍨als to all kinds of investors for a variety of reasons.

With a single, convenient purchase, they offer investors a diversified portfolio of securities (e.g., across sectors and asset classes such as stocks, bonds, currencies, real estate, and commodities). They trade on an exchange, are usuall♛y liquid ✤instruments, and can be bought or sold easily by individuals.

Moreover, their expense ratios typically are low, making them very a🗹ccessible to a wide range of in🔥vestors. All told, they can be excellent investments for long-term wealth-building.

In addition and importantly, ETFs can function as a tool to hedge existing positions to manage various types of risks. They🍰 can be a cost-effective alternative to forward contracts, futures, and opti💃ons.

In this article, we'll look at the benefits of hedging with ETFs and a few ETF hedging strategies.

Benefits of Hedging With ETFs

Historically, hedging has been limited to the use of derivative-based securities such as futures, options, and over-the-counter securities.

Because the pricing of such securities is based on advanced mathematical formulas, such as the 澳洲幸运5官方开奖结果体彩网:Black-Scholes opꦕtions pricing models, managing risk through hedging often has been undertaken only by sophisticated inst🌸itutional investors.

Withও that in mind, using ETFs for hedging purposes could quite naturally attract smaller investors. They can purchase and sell ETFs on any day during market hours, in increments that they can afford. And there are a sufficient number of ETFs from which to choose to match the investments that they may wish to he𓄧dge.

Also, many retail investors can more readily understand ETFs compared to futures and 💦forward contracts. And,🌜 their aforementioned low cost, even compared to mutual funds, is a major reason why many investors use them for direct investing and as a vehicle for hedging.

Hedging Stock Market Positions

Investors often use futures and options to 澳洲幸运5官方开奖结果体彩网:hedge their positions in stocks and bonds. One of the most common and actively traded securities in the equity market, for example, is 澳洲幸运5官方开奖结果体彩网:S&P 500 Index futures.

They are used widely 🙈by large institutions including pension funds and mutual funds, as well as by active traders, to protect against adverse market mov🌜es.

Using ETFs

ETFs like ProShares Short S&P500 (SH) and ProShares UltraPro Short S&P500 (SPXU) move inversely to the S&P 500 Index and can be used in lieu of futures contracts to 澳洲幸运5官方开奖结果体彩网:hedge against a d👍rop in the S&P and take short positions in the general stock market. ETFs make these positions simpler and cheaper to take. They may also be more liquid compared to their futures contracts counterparts.

While the hedging mechanics of 澳洲幸运5官方开奖结果体彩网:short equity ETFs, also known as inverse ETFs, are much different than futures, and the ability to match the positions is not precise, 澳洲幸运5官方开奖结果体彩网:buying a short ETF🌞 is a p♚ractical alternative for achieving the goal of risk management.

That is, the share price of the inverse fund will increase in value if the stock market falls. That profit can help offset losses suffered by stocks within the portfolio that decrease in value.

Hedging Currency Positions

As with the management of equity market risk, before the advent of ETFs, the exchange rate risk carried by currency-related investments was hedged using futures, forward contracts (often agreements between large entities and traded ov🐽er-the-counter), and options.

And again, many individual investors aren't normally that comfortable with such securities. To some, they may not seem as straightforward as ETFs.

For example, as with interest rate swaps, forward contracts allow one party to assume the risk of a 澳洲幸运5官方开奖结果体彩网:long position and the other party to assume a 澳洲幸运5官方开奖结果体彩网:short position in a currency.

By design, the participants rarely take physical delivery of the currency position and choose to cash out the ending value based on the closi🉐ng currency exchange rate. During the life of the forward contract, no money is exchanged, and the valuation is typically based on the appreciation/depreciation of the swap or held at cost.

Using ETFs

Smaller investors can hedge the 澳洲幸运5官方开奖结果体彩网:exchange rate risk of their non-U.S. investments by buying a sufficient increment of a 澳洲幸运5官方开奖结果体彩网:currency ETF with a short U.S. dollar position. One example of such an ETF is the Invesco DB U.S. Dollar Index Bearish fund (UDN).

Likewise, an investor outside of the U.S. could initiate a hedge by buying a currency ETF with a long U.S. dollar position. A choice for this strategy might be the Invesco DB U.S. Dollar Index Bullish fund (UUP).

It's up to individual investors to match portfolio value with an appropriate ETF hedge position. But thanks to the liquidity of ETFs and the fact that (unlike options and futures) ETFs never expire, investors can easily make adjustments (add more ETF shares or sell some), as needed.

Hedging Inflation Risk

The inflation risk that confronts consumers and businesses is ever present. It's also a destructive power that investors need to manage. ETFs can offer a solution for managing the risk that rising prices poses for their savings 🅠and investments.

In this case, commodities are the investment that investors typically choose to counter a decrease in the value of their portfolios. That's because when inflation rises, the prices of commodities are expected to rise as well. Therefore commodity ETFs can make a great hedging tool in which to take an opposing position to a portfolio of, for example, stocks and bonds.

Many ETFs offer eas🍰y and convenient exposure to commodities such as prec꧟ious metals, energy, and natural resources.

Some examples of precious metals ETFs include the SPDR Gold Shares fund (GLD) and the ProShares Ultra Silver fund (AGQ).

Energy ETFs include the U.S. Oil Fund (USO) and the Invesco DB Oil fund (DBO).

Natural resources ETFs include the SPDR S&P Global Natural Resources fund and the iShares North American Natural Resources fund.

There are also broad commodity ETFs, such as the Invesco DB Commodity Index Tracking fund (DBC) that invests in commodity futures.

The Bottom Line

The benefits of using an ETF for hedging are numerous. First and foremost is cost-effectiveness, as ETFs allow investors to take positions with little or no entrance fees (commissions) and low expense ratios.

In addition, since ETF shares trade like stocks, the process of buying and selling an ETF is a straightforward process for most individual investors. Lastly, ETFs cover many markets, including 澳洲幸运5官方开奖结果体彩网:stocks, bonds, and commodities.