Strategic Guide: Using Inverse ETFs to Short the Financial Sector

The financial sector has taken a beating this year, with the Financial Select Sector SPDR Fund (XLF) down 22.4% versus a 5.7% loss for the broader S&P 500 (SPY). What’s driving this weakness? A combination of headwinds has crushed bank stocks: negative interest rates abroad, flattening yield curves, energy sector stress, and persistent capital outflows from financial ETFs.

Understanding the Headwinds

The triggers are multifaceted. Central banks in Japan and Europe have signaled lower rates or additional stimulus, while U.S. rate hike expectations have dampened. As yields compress, the three-month to 10-year Treasury spread—critical for bank profitability—has narrowed to 2012 lows, squeezing net interest margins.

Energy sector woes compound the problem. Banks with heavy exposure to oil and gas are provisioning aggressively for loan defaults, eating into earnings. Meanwhile, negative or near-zero rates discourage deposits, further pressuring financial institutions. XLF itself has seen $1.6 billion in outflows despite $25.3 billion in assets, signaling institutional retreat from the space.

For traders convinced this weakness will persist, short financial ETF positions offer tactical opportunities.

Inverse ETF Options for Shorting Financials

Unleveraged Short Strategies

ProShares Short Financials (SEF) delivers straightforward inverse exposure to the Dow Jones U.S. Financials Index at a 0.95% expense ratio. With $40.6 million in AUM and light trading volume around 41,000 daily shares, this unleveraged product is ideal for conservative hedging. Year-to-date returns: +12%.

ProShares Short S&P Regional Banking (KRS) focuses specifically on regional banks, the segment most vulnerable to margin compression. Holding just $1.4 million in assets with minimal daily volume (under 2,000 shares), KRS is illiquid but has posted +20.9% year-to-date gains at a matching 0.95% fee.

2x Leveraged Exposure

ProShares UltraShort Financials (SKF) amplifies inverse returns to 2x the Dow Jones U.S. Financials Index, charging 95 basis points annually. With $71.9 million in AUM and moderate daily volume around 57,000 shares, SKF has delivered approximately 24% year-to-date performance—capturing leveraged downside during the sector’s decline.

3x Leveraged Positions

For aggressive traders, three-times leverage multiplies both gains and risks:

ProShares UltraPro Short Financial Select Sector (FINZ) targets the S&P Financial Select Sector Index with 3x inverse exposure. The fund holds just $2.3 million in AUM with sparse liquidity (5,000 daily shares) and charges 95 bps, but has surged 39.4% year-to-date.

Direxion Daily Financial Bear 3x Shares (FAZ) offers the most robust vehicle in this category. Tracking the Russell 1000 Financial Services Index with 3x leverage, FAZ boasts $378.7 million in AUM and heavy daily trading volume exceeding 1.3 million shares, making it far more accessible than peers. Year-to-date gain: 33.8%.

Direxion Daily Regional Banks Bear 3x Shares (WDRW) zooms in on regional bank weakness with 3x inverse exposure to the Solactive Regional Bank Index. Despite only $2.6 million in AUM and minimal daily volume (1,000 shares), the illiquid fund has exploded 53.3% year-to-date, reflecting regional banks’ acute vulnerability.

Key Considerations for Short Traders

These products are rebalanced daily, making them suitable exclusively for short-term tactical positions, not long-term holdings. Daily rebalancing can create drag or windfall depending on market volatility—a critical distinction from buy-and-hold strategies.

The gap between AUM and daily volume reveals liquidity disparities. FAZ’s popularity and substantial volume make it the most liquid 3x short financial option, while WDRW and FINZ appeal only to traders willing to accept execution challenges.

Expense ratios uniformly sit at 0.95% (leveraged) or 0.95% (unleveraged), which compound over time and erode returns during sideways markets.

Verdict

For investors convinced financial stocks face near-term pressure, the short financial ETF landscape offers vehicles across the risk spectrum. Fundamentals suggest further deterioration likely—margin compression, deposit flight, and energy loan stress won’t resolve overnight. Risk-tolerant traders holding a shorter time horizon might exploit this outlook through any of the above products, though liquidity and leverage should guide final selection.