Tail Risk Hedging ETFs

A form of protecting funds during a market crash, tail risk hedging ETFs also helped out many investors during 2020 and 2022. They protect the investor’s portfolio, but they also aim to create positive returns when the market experiences a big decline. The profits that come from using these ETFs can offset the losses that a diversified portfolio would incur from the situation.

Using credit spreads is much less risky than naked options. Credit spreads involve receiving a premium from the sold options that is greater than the premium paid for the purchased options, which ultimately results in a net credit. The risks are higher with using naked options, specifically the potential for unlimited losses.

Another common strategy for making money during a crash is a strategy referred to as “shorting VIX post-peak,” where traders will bet that volatility will decrease; they hope that volatility will revert to its average once the initial crash has occurred. Investors who pulled this move in mid- to late-March of 2020 were not disappointed when the market made a quick recovery following March 23, when it hit rock bottom.

A long-term strategy that traders took advantage of during March 2020 was using some of their stockpiled cash or “dry powder” to buy up Long-Term Equity Anticipation Securities (LEAPS contracts) around the time of the market hitting rock bottom, knowing that these contracts were likely to increase in value once the market corrected. Specifically, buying LEAPS on quality stocks near the bottom in 2020 paid off big.

Due to the longer time horizon of three to five years on these contracts, LEAPS options allow for a lot of time for the asset to move in the right direction. In most cases, the environment following a market crash is likely to make LEAPS go up in value right away because the market has nowhere to go but up.