Inverse Strategies

Lesson

Inverse strategies are investment techniques that aim to profit from the decline in the value of an underlying asset or index. These strategies are often used by investors to hedge their portfolios against market downturns or to speculate on the potential decline in the value of a particular asset.

Practice Question #1

Which of the following is an example of an inverse strategy?

A) Purchasing a call option

B) Short selling a stock

C) Buying a stock on margin

D) Investing in a passive index fund

Select an option above to see an explanation here.

A) Purchasing a call option is a bullish strategy, not an inverse strategy. B) Short-selling a stock is an inverse strategy, as it aims to profit from a decline in value. C) Buying stock on margin is a leveraged strategy, not an inverse strategy. D) Investing in a passive index fund is a passive investing strategy, not an inverse strategy.

Terms

Inverse ETF:: An exchange-traded fund that performs inversely to its benchmark index.
Short selling:: The practice of selling borrowed securities to repurchase them at a lower price to profit from the decline in their value.
Put option:: A financial contract that gives the holder the right, but not the obligation, to sell an underlying asset at a specified price before a specified expiration date.

Practice Question #2

What is the primary purpose of using inverse strategies in a portfolio?

A) To increase diversification

B) To hedge against market downturns

C) To speculate on market trends

D) To generate income

Select an option above to see an explanation here.

A) While inverse strategies can add diversification to a portfolio, their primary purpose is to hedge against market downturns. B) Inverse strategies are used to hedge against market downturns by profiting from declines in asset values. C) Speculation on market trends can be a secondary purpose of using inverse strategies, but their primary purpose is hedging. D) Inverse strategies are not primarily used to generate income but to hedge against market downturns.

Do Not Confuse With

Long positions:: Investments made with the expectation that the underlying asset's value will increase.

Practice Question #3

Which of the following is NOT an example of an inverse strategy?

A) Purchasing a put option

B) Investing in an inverse ETF

C) Short selling a stock

D) Buying a stock on margin

Select an option above to see an explanation here.

A) Purchasing a put option is an inverse strategy, as it aims to profit from a decline in the underlying asset's value. B) Investing in an inverse ETF is an inverse strategy, as it aims to perform inversely to its benchmark index. C) Short-selling a stock is an inverse strategy, as it aims to profit from a decline in value. D) Buying stock on margin is a leveraged strategy, not an inverse strategy.

Historical Example

In the 2008 financial crisis, many investors used inverse strategies to profit from the decline in the value of financial stocks and other assets. These strategies included short selling, purchasing put options, and investing in inverse ETFs and mutual funds.