Strategies for Trading ETF Options

More people than ever have discovered the immense benefits of ETF options trading and are staking their claims on large swaths of stocks with options on ETFs.  There are a few reasons investors trade ETF options, as we'll explain below.

Sector Plays

Exchange-traded funds
first emerged as index funds, followed by sector funds, to track stocks of a certain market index (the S&P 500, for example) or a sector (transportation, consumer staples, retail, etc), respectively.  Today, ETF options trading has grown as a way to leverage up on a single growing sector without excessive exposure to just one company.

Have you ever thought a particular sector might explode in growth?  Ever thought some new emerging technology or a shift in global trends would make a whole community of companies richer or poorer?  If so, ETF options trading is just for you. 

News Trades

ETF options are a great way to play news releases without exposing yourself to a lot of risk.  Since you can control several hundred shares with a tenth of the cost of the shares themselves, options on ETFs are an excellent way to gamble on news events with limited downside risk. 

To play the consumer confidence news via ETF options trading, one might purchase a lot of options on a retailers ETF.  If the trader expects falling consumer confidence, he or she may sell calls or buy puts.  Likewise, on an expected rise, a trader may buy calls or sell put options on ETFs.

ETF options trading is also used to play earnings news on a single stock that may affect a whole sector.  For instance, if you think Intel will beat earnings expectations, but you would rather have the lessened volatility (but near similar tracking) of a technology ETF, you may buy options on ETFs like the IYW ETF.

Banking on Trendlines

Finally, one popular strategy is to buy options on ETFs that are currently near a trendline.  Since trendlines can break at any moment, but usually provide some support or resistance, they are excellently paired with ETF options.

When a trendline is broken, typically a violent move occurs as a result.  Without proper downside protection, a trader may lose a significant portion of their bankroll on just one trade.  Not with ETF options!  By purchasing options with a strike price near the trendline, the losses are reduced to the amount of the premium only.  That is, a $.10 premium paid for a call with a $20 strike and a current stock price of $18 is equivalent to purchasing a share of stock at $18, but with losses limited to just $.10, or a fall to $17.90.  With ETF options, the stock can plunge from $18 to $15, and the trader would lose only the premium, or $.10.  With stocks, the loss would be some thirty times larger at $3.00 per share.

ETF options trading has very obvious perks of which all traders should be aware.  Whether you're looking to limit your risks, spread out your investments among several companies, or double up with the help of natural leverage, ETF options provide an excellent and inexpensive tool to master the markets.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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