How to Use Options With ETFs | ETF Trends

Exchange traded funds (ETFs) are useful investment tools and trading options on ETFs is one of the many ways you can maximize the benefits of them.

Trading options on ETFs could potentially allow traders to use the leverage of derivative markets to increase gains from ETF trades, writes David Penn for Yahoo! Finance. It should be noted that not all ETFs have liquid options, which means most investors should stick with more widely-traded index ETFs and liquid country ETFs.

Calls are options used when the prices are thought to be heading higher – they give an investor the right, but not the obligation, to buy a stock at a pre-set price.In other words, you’re “reserving” today’s prices for an item that you think may be priced higher at a future date.

Penn says the basic options strategy for ETF traders is buying deep in the money calls with long signals in ETFs, or buying deep in the money puts to fulfill short ETF signals. Let’s translate that.

“Deep in the money” refers to calls that have a strike price that is 2 or 3 strike prices below the current price of an ETF. As an example, if an ETF were priced at $44 and a long signal on the close was received, a deep in the money call would be a call with a strike price of $40 or even $35.