7 – L2 06 Hedging V3

Now, let’s discuss how investors can use ETFs for hedging. Recall that hedging generally means entering into a transaction in order to reduce exposure to price fluctuations. Let’s see how hedging works with ETFs. If you have a portfolio that holds many stocks in the S&P 500, you can take some short positions in an ETF that tracks the S&P 500. The most popular is the SPDR S&P 500 ETF, which is issued by State Street Global Advisors. Note that it’s spelled S-P-D-R and pronounced spider. When the overall market moves down, your portfolio goes down with it. However, your short positions in the SPDR ETF gain at the same time limiting the impact of the market downturn. Note that the reverse happens when the market goes up. Your long investments will go up with a market, while your short positions in the ETF will lose reducing your net gain. Active fund managers may also short ETFs in order to reduce their portfolio’s exposure to certain sectors, industries, or regions. For example, a hedge fund whose portfolio includes tech stocks may wish to short an ETF, such as the Fidelity MSCI Information Tech ETF, in order to cancel out some of the price fluctuations in the tech industry.