An exchange traded fund (ETF) is a collection of assets that trades like a single stock. Many ETFs come with options available so you can use them for covered calls. They make sense for covered calls because of the inherent diversification they provide (especially true in smaller accounts). Because of the way ETFs are constructed, there is no single stock risk. If one of the stocks that makes up the ETF drops dramatically then the effect will be felt less by the ETF that contains that stock than by the stock itself.
Many ETFs track a specific index, allowing you a low-cost way to trade the index. Take IWM, for example, which represents an ETF that is comprised of two thousand stocks that make up the Russell 2000. When you purchase IWM you are buying a basket made up of two thousand stocks. Other popular ETFs include the S&P 500 (symbol SPY) and the NASDAQ 100 (symbol QQQQ). And there are ETFs to track specific commodities, sectors, or countries. For example, EWZ tracks Brazil, EWJ tracks Japan, XLF tracks financial stocks, and GLD tracks gold bullion.
GLD is an interesting one given investor interest in owning gold. But one drawback is that GLD doesn't pay dividends. However, by using covered calls you can generate monthly income from gold, too. Buy a gold ETF and write covered calls (at-the-money if you're neutral on gold, or out-of-the-money if you're bullish on gold). GLD is the most highly traded gold ETF and definitely the best bet for covered call trading. UGL is two times leveraged and therefore quite volatile, and DGL has very small open interest.
To be properly diversified you will want some emerging markets exposure in your portfolio. But given the challenge of finding reliable, solid information on companies in foreign countries, the safer way to play emerging markets is with a group of stocks in an ETF. The most popular emerging market ETF is EEM (iShares MSCI Emerging Markets Index Fund), which has over $39 billion in assets and is about as liquid as it gets. If you want to limit your exposure to just one country, say China for example, then you can use FXI (iShares FTSE/Xinhua China 25) to write calls against.
Despite all the benefits of using ETFs for covered calls, there is one kind of ETF that you should not get involved with, and those are the leveraged ETFs. They are 2 or 3 times more volatile than a their unleveraged counterparts. You can spot leveraged ETFs because they usually have words in their name like "double", "2x", "ultra", "triple", "3x", or "leveraged". Traders who day trade love leveraged ETFs. Good for them. But that does not mean they are appropriate for covered calls written by conservative income-oriented investors (they're not!). They can be tempting because the high premiums they offer. But the extreme volatility is the reason for those high premiums! Better to stick with unleveraged ETFs for writing covered calls.
Many ETFs track a specific index, allowing you a low-cost way to trade the index. Take IWM, for example, which represents an ETF that is comprised of two thousand stocks that make up the Russell 2000. When you purchase IWM you are buying a basket made up of two thousand stocks. Other popular ETFs include the S&P 500 (symbol SPY) and the NASDAQ 100 (symbol QQQQ). And there are ETFs to track specific commodities, sectors, or countries. For example, EWZ tracks Brazil, EWJ tracks Japan, XLF tracks financial stocks, and GLD tracks gold bullion.
GLD is an interesting one given investor interest in owning gold. But one drawback is that GLD doesn't pay dividends. However, by using covered calls you can generate monthly income from gold, too. Buy a gold ETF and write covered calls (at-the-money if you're neutral on gold, or out-of-the-money if you're bullish on gold). GLD is the most highly traded gold ETF and definitely the best bet for covered call trading. UGL is two times leveraged and therefore quite volatile, and DGL has very small open interest.
To be properly diversified you will want some emerging markets exposure in your portfolio. But given the challenge of finding reliable, solid information on companies in foreign countries, the safer way to play emerging markets is with a group of stocks in an ETF. The most popular emerging market ETF is EEM (iShares MSCI Emerging Markets Index Fund), which has over $39 billion in assets and is about as liquid as it gets. If you want to limit your exposure to just one country, say China for example, then you can use FXI (iShares FTSE/Xinhua China 25) to write calls against.
Despite all the benefits of using ETFs for covered calls, there is one kind of ETF that you should not get involved with, and those are the leveraged ETFs. They are 2 or 3 times more volatile than a their unleveraged counterparts. You can spot leveraged ETFs because they usually have words in their name like "double", "2x", "ultra", "triple", "3x", or "leveraged". Traders who day trade love leveraged ETFs. Good for them. But that does not mean they are appropriate for covered calls written by conservative income-oriented investors (they're not!). They can be tempting because the high premiums they offer. But the extreme volatility is the reason for those high premiums! Better to stick with unleveraged ETFs for writing covered calls.
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