Best Gold And Emerging Markets ETFs For Covered Calls
ETFs (Exchange Traded Funds) are baskets of stocks that trade like a single stock. Many of them are optionable (meaning there is a market for calls and puts on the ETF) so you can use them for covered calls. They make sense for covered call writers because of the inherent diversification they provide (especially true in smaller accounts that may not have the capital to buy many different stocks for diversification). There is no single-stock risk with an ETF. If one of the constituent stocks drops dramatically then the effect will be felt less by the exchange traded fund that includes that stock than by the single stock by itself.
ETFs that track specific indexes allow you an easy way to trade the index. For example, the Russell 2000 index can be traded through the ETF with symbol IWM. There are two thousand stocks in IWM so by definition it has no single-stock risk. Other popular ETFs with many constituent components include QQQQ (NASDAQ 100) and SPY (S&P 500). Or, if you want something that follows specific sectors, countries, or commodities, you can do that with ETFs, too. For example, XLF tracks financial stocks, EWZ tracks Brazil, EWJ tracks Japan, and GLD tracks gold.
GLD is an interesting one given most people’s interest in owning gold. But one drawback is that GLD doesn’t pay cash dividends. However, by using covered calls you can generate recurring income from gold, too. Buy a gold ETF and write 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.
Much like gold, investors should always have some exposure to emerging markets for diversification. That is especially true considering the volatilities in the forex markets. But emerging markets information is often inconsistent, difficult to come by, and in a format that is difficult to understand. So it’s another good opportunity for ETFs. The most common emerging markets ETF is the iShares MSCI Emerging Markets Index Fund (EEM), which has nearly $40 billion in assets. It is highly liquid, which is an attribute you like to see when investing in general, and specifically when selling covered calls. Another choice, if you want to limit your exposure to just China, perhaps, would be to use iShares FTSE/Xinhua China 25 (FXI) instead.
There is one kind of ETF that you should not get involved with for covered calls, and those are the leveraged ETFs. Leveraged ETFs are designed to be much more volatile than an unleveraged ETF. You can usually identify leveraged ETFs because they have words in their name like “double”, “ultra”, “triple”, “2x”, “3x”, or “leveraged”. Leveraged ETFs are mostly used by day traders and are not good choices for conservative income-oriented covered call investors. It can be tempting because the premiums are almost always pretty high. But there’s a reason for those fat premiums, so beware! Leveraged ETFs are, by design, two or three times more volatile than their unleveraged counterparts.
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