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ETF Options - Why You Should Trade Them

Grow a Small Account Quickly with ETF Options

ETF Options when combined with the right options strategy, can be one of the best and safest ways to profit consistently from the financial markets. Here, we're going to explore some of the reasons why.

Firstly, ETFs, which is short for Exchange Traded Funds, are available for a wide range of markets including stock indexes, stock market sectors, various commodity sectors and currencies, foreign and domestic.

This provides great versatility for the active trader because even though one market may be quiet at any given point in time, another one will be on the move. For example, the stock market may be going nowhere but a currency is trending, and so forth.

If you wanted to trade the currency or commodity markets while enjoying the benefits of leverage, you would probably have to resort to futures, Contracts for Difference (if outside the USA) or forex pairs.

Trouble is, all these types of financial instruments carry unlimited risk - which means that should market price action turn against you in a big way, you can lose more than the amount you have risked on the trade.

The maximum risk when buying options on the other hand, is limited to the investment amount - and if your preference is to trade simple long options positions, ETF Options are your best choice.

Here's why:

1. Most ETF options have low implied volatility, which is what you want if you're buying options. This low IV also means that should the trade be going against you, your losses will be reduced because you have bought the options cheaply in the first place. Low IV also allows you to give yourself the gift of time for the trade to work out in your favour.

2. ETFs have no huge and sudden price surges that arise from news events such as earnings reports, management incompetence, product disasters, SEC investigations or the like. This is because they represent huge underlying, often broad based, markets, where the fortunes of individual companies can't affect the market as a whole.

3. ETF options are traded on high daily volume and since the underlying market is huge and broad based, price action cannot be manipulated by market makers. This allows you to leave the trade active and sleep at night.

4. Unlike individual companies, Exchange Traded Funds tend to trend in a predictable and fairly even manner. Once a trend is established, it is more likely to continue rather than whipsaw all over the place.

5. ETF options can be purchased for a few cents, which is very good for traders with small accounts. For a few hundred dollars you can set yourself up for many times that in profit. It also means there is no need to employ advanced options strategies along with their increased brokerage fees. You can just buy single options positions.

6. Since ETF options are available on securities other than stock market based instruments, (even though they behave like stocks, paying dividends and the like) you can use them when the stock market is showing price volatility.

For example, the Dow Jones might fall 300 points in one day, but on the same day, a commodities based ETF may rise moderately, or a currency based ETF may even trend upward. This allows investors to broaden their portfolio of positions so that they are not entirely at the mercy of the stock market.

This is ideal for those using the popular Trading Pro System, which teaches you how to approach option trading like running a business, understanding and using the greeks.

Like any business, you need a portfolio of unrelated products - in this case, option contracts - so that even if one "product line" only breaks even, your entire "business" still makes an overall profit.

A Simple ETF Options Strategy

Let's say you can see that the Japanese Yen is falling. Did you know that the Yen has an ETF in the US markets and there are also options on this ETF? It's symbol is the FXY.

You use the weekly charts for the Yen as your guide to how far the currency can be expected to move. You then apply fibonacci percentages to anticipate your profit targets.

So you purchase put options contracts on the FXY, each having a delta of -20 and at least 4 months to expiration date. Most brokers will give you the options delta. The cost for these options would be around 25 cents each, so if you purchased 10 contracts, the risk would be 10 x 100 x 0.25 = $250.

This way, you risk the smallest amount but with the greatest potential leverage and four months for it to realize a good return on investment without time decay being a major factor.

ETFs will often move between 8-10 percent in value over a few months. This will push your cheap options deep into the money where the profits can be spectacular.

It is important that using the above strategy, you pay attention to position sizing. Never risk too much on any one trade! There are plenty of ETFs with options to provide multiple trading opportunities - and all you need are some trades with impressive profits to outweigh the small losses you might experience on other trades where your dirt cheap options with low IV don't work out.

Here's a List of Some ETFs with Options

QQQ - follows the Nasdaq 100

DIG - follows the price of oil and gas

EWJ - Japan Index for smaller accounts; can't chart it though

EFA - iShares MSCI EAFE Index Fund

EWZ - iShares MSCI Brazil Index Fund

USO - United States Oil Fund

GLD - follows the Gold price

GDX - Market Vectors Gold Miners

XLE - follows the energy sector

XLF - follows the financial sector

XRT - SPDR S&P Retail

IWM - follows the Russell 2000 stock index

EEM - follows the emerging markets sector

DIA - follows the Dow Jones Industrial Average

SPY - follows the S&P500 index

SLV - follows the price of Silver

UNG - follows the price of natural gas

NUGT - triple leverage ETF but IV is higher, but moves really well

DUST - triple leverage bearish gold ETF, IV is higher, but moves really well