Author : Ahmad Hassam

You must have traded ETFs No, then let me first introduce you to ETFs ETF is the short acronym for Exchange Traded Funds ETF are a basket of stocks or other assets that have been designed to closely track a stock index, a market index, sector index or any other index Now trading stock indexes is what many trader do You can trade stock indexes with options However, trading ETF Options can be a more profitable venture for you!

The most important difference is that Index Options are cash settled on expiry while the ETF Options are settled with the underlying instruments that is shares of that ETF Since with an ETF Options, you can also own the underlying security, you can use various combination strategies

Index and ETFs both get affected by the dividends paid by the underlying stocks So if you use options on them, these dividends on the underlying stocks should be incorporated into the puts and calls by using an options calculator

Now, ETF Options are more flexible than the Index Options as you can use the underlying ETF as well in your options strategies If you have already traded stock options, ETF options should not be difficult for you You can hedge your ETF position with an option on the ETF

Using Protective Put Strategy by combining long ETF with a long put can hedge against the downside risk limiting it to the put strike price with a slightly increased cost for the ETF

Similarly, you can use a Covered Call on ETF A Covered Call is formed by taking combining long ETF with a short call on that ETF The short call will give you some income in the shape of a premium and reduce the cost of the position This will also slightly reduce the risk of the position But on the other hand, a covered call will limit the upside profit potential Your max profit now will only be limited to the call strike price

Another combination strategy that you can use with an ETF is forming a Collared Position A Collared Position is formed with a long ETF and a long put combined with a short call A Collared Position limits the limited but high risk to a limited risk only The downside risk is now only limited to the put strike price The premium paid in taking a long put position is offset somewhat by the premium that you get by writing a call

Options trading is risky in the sense that it has both time volatility as well as price volatility Now, many traders trade options without getting good options trading education What you need to do is first paper trade these strategies and master them This way you will learn how to deal with unexpected risk

An important fact that you need to know is that not all ETFs have options written on them This should not surprise you as there are many stocks that don’t have options written on them Another important fact that you should know is that ETF Options are always American Style American Style options can be excercised anytime before expiry You can even trade LEAP Options on ETFs LEAP Options are long term options having expiry of more than nine months to less than two and a half years

Mr. Ahmad Hassam has done Masters from Harvard.Read this FREE 40 page PDF FRWC Brutal Truth Report on automated trading systems. Read this shocking FREE 49 page Quantum Swing Trading Report!

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Filed under: Finance

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