Let's say you think the market is heading down in the next 6 months. Is it better to buy put options of an ETF (e.g., SPY) or buy an inverse ETF (e.g., SH)? or a leveraged inverse ETF (e.g., SPXU) to try to get bigger gains on market drops? What are the pros and cons of each?


You don't have to think it is going down, it is currently trending down as on a weekly chart there are lower lows and lower highs. Until there is a higher low with confirmation of a higher high, the downtrend will continue.

The instrument you use to profit from a market drop depends on your risk profile, the time frame you are looking at, and your trading plan and risk management.

With a put option your loss is limited to your initial premium and your potential profits can be quite large compared to the premium paid, however your timeframe is limited to the expiry of the option. You could buy a longer dated option but this will cost more in the premium you pay.

With inverse ETF you are not restricted by an expiry date, but if you don't have appropriate risk management in place your potential losses can be large.

With a leveraged inverse ETF again you are not restricted by an expiry date, you can potentially make higher percentage profits than with an standard ETF. but once again your losses can be very large (larger than you initial investment) if you don't have appropriate risk management in place.

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    mmm... no? How can you lose more than your initial investment with a leveraged ETF? Inverse ETFs(leveraged, or not) can go bankrupt(underlying* multiple >= 100%) but even in that case you only lose 100% of your initial investment unless you keep throwing money or are buying them on margin. Also, the downtrend continuing based on some definition, is a technicality. By the time the trend is broken you have lost your shirt especially in inverse leveraged ETFs. – user14199 Feb 23 '16 at 8:08

The only use of options that I will endorse is selling them. If you believe the market is going down then sell covered, out of the money, calls.

Buying calls or buying puts usually wastes money. That is because of a quality called Theta. If the underlying security stays the same the going price of an option will decrease, every day, by the Theta amount.

Think of options as insurance. A person only makes money by selling insurance, not by buying it.

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Depends on how far down the market is heading, how certain you are that it is going that way, when you think it will fall, and how risk-averse you are. By "better" I will assume you are trying to make the most money with this information that you can given your available capital.

If you are very certain, the way that makes the most money for the least investment from the options you provided is a put. If you can borrow some money to buy even more puts, you will make even more. Use your knowledge of how far and when the market will fall to determine which put is optimal at today's prices. But remember that if the market stays flat or goes up you lose everything you put in and may owe extra to your creditor. A short position in a futures contract is also an easy way to get extreme leverage. The extremity of the leverage will depend on how much margin is required. Futures trade in large denominations, so think about how much you are able to put to risk.

The inverse ETFs are less risky and offer less reward than the derivative contracts above. The levered one has twice the risk and something like twice the reward. You can buy those without a margin account in a regular cash brokerage, so they are easier in that respect and the transactions cost will likely be lower.

Directly short selling an ETF or stock is another option that is reasonably accessible and only moderately risky. On par with the inverse ETFs.

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Use leveraged inverse etfs. You are not paying for Theta decay , ie: (time). This is a huge cost saving. The only drawback is option convexity. In other words large volitility events favor the use of options as they accelerate in value. Yes you would actually make money in a fully hedged position using options during a severe downturn or low probability event. However the inverse etf reduces the daily losses from using options which is an extremely high probability event. The math favors the leveraged etf in almost all instances,

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