A Strategy for Trading Options on Index ETFs


Nationwide Risk-Managed Income ETF (NYSEARCA:NUSI) is only just short of two years old. It is structured to provide income in this low-yield environment without using Fixed Income assets that would be hurt when interest rates start to return to levels considered “normal”. Their strategy is also designed to provide NASDAQ 100 exposure with less risk. The strategy used to accomplish both goals is their Protective Collar Options strategy. Understanding that is critical to appreciating what NUSI brings to the market.

For investors looking for more income, like the stocks that make up the NASDAQ 100 Index and are willing to forego some capital gains for limiting damage when the market drops over 10%, I would give the Nationwide Risk-Managed Income ETF a Bullish rating.

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4. Brazil iShares MSCI ETF (EWZ)

Brazil iShares MSCI ETF [EWZ] is an investment vehicle for traders who are interested specifically in Brazil; it targets large and mid-sized Brazilian companies.

Brazilian economic growth was disappointing in 2018, due to a slowdown in demand and a truck drivers’ strike that disrupted the country’s manufacturing industry and logistics.

However, new president Jair Bolsonaro has pledged to open up the country’s economy to make it friendlier to business interests.

8. SP 500 Financials Sector SPDR (XLF)

The S&P 500 Financials Sector SPDR [XLF] tracks financial stocks in the S&P 500 index, weighted by their market capitalization.

This includes exposure to a variety of subindustries within finance: banking, insurance, financial services, consumer finance, real estate investment trusts (REITs), and more. J.P. Morgan [JPM] and Wells Fargo [WFC] are just two of the names attached to this ETF.

How much money do you need to trade options?

If you’re looking to trade options, the good news is that it often doesn’t take a lot of money to get started. As in these examples, you could buy a low-cost option and make many times your money. However, it’s very easy to lose your money while “swinging for the fences.”

If you’re looking to get started, you could start trading options with just a few hundred dollars. However, if you make a wrong bet, you could lose your whole investment in weeks or months. A safer strategy is to become a long-term buy-and-hold investor and grow your wealth over time.

2. Covered call

A covered call involves selling a call option (“going short”) but with a twist. Here the trader sells a call but also buys the stock underlying the option, 100 shares for each call sold. Owning the stock turns a potentially risky trade — the short call — into a relatively safe trade that can generate income. Traders expect the stock price to be below the strike price at expiration. If the stock finishes above the strike price, the owner must sell the stock to the call buyer at the strike price.

Example: Stock X is trading for $20 per share, and a call with a strike price of $20 and expiration in four months is trading at $1. The contract pays a premium of $100, or one contract * $1 * 100 shares represented per contract. The trader buys 100 shares of stock for $2,000 and sells one call to receive $100.

Here’s the profit on the covered call strategy:

Reward/risk: In this example, the trader breaks even at $19 per share, or the strike price minus the $1 premium received. Below $19, the trader would lose money, as the stock would lose money, more than offsetting the $1 premium. At exactly $20, the trader would keep the full premium and hang onto the stock, too. Above $20, the gain is capped at $100. While the short call loses $100 for every dollar increase above $20, it’s totally offset by the stock’s gain, leaving the trader with the initial $100 premium received as the total profit.

The upside on the covered call is limited to the premium received, regardless of how high the stock price rises. You can’t make any more than that, but you can lose a lot more. Any gain that you otherwise would have made with the stock rise is completely offset by the short call.

The downside is a complete loss of the stock investment, assuming the stock goes to zero, offset by the premium received. The covered call leaves you open to a significant loss, if the stock falls. For instance, in our example if the stock fell to zero the total loss would be $1,900.

When to use it: A covered call can be a good strategy to generate income if you already own the stock and don’t expect the stock to rise significantly in the near future. So the strategy can transform your already-existing holdings into a source of cash. The covered call is popular with older investors who need the income, and it can be useful in tax-advantaged accounts where you might otherwise pay taxes on the premium and capital gains if the stock is called.

Here’s more on the covered call, including its advantages and disadvantages.

Which SP 500 ETF Is Most Suitable for the Wheel Strategy?

There are 3 popular ETFs that track the S&P 500, which are SPY, IVV and VOO. The 3 ETFs have different tracking accuracies, different management fees, so you might wonder which one is most suitable for the Wheel Strategy.

Since the Wheel trading strategy uses options to boost the returns on investing the underlying for the long-term, we choose the best ETF by the volume of options traded for each ETF.

S&P 500 ETFDaily options volume

By comparing the options volume for each of the 3 ETFs, we can tell SPY has exponentially more options liquidity than the other 2. So we will choose SPY is the symbol for trading the Wheel Strategy.

Differences Between Holding SPY ETF and the Wheel Strategy

If buying and holding shares of SPY can expect 9% average return a year, then we can add 19% more from the premium of the Wheel Strategy, tripling our annual returns on investing in SPY.

StrategiesHolding SPY ETFWheel strategy
Minimum cost$383$77,000
Annual return9%28%

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Selling Put Options

When you sell put options, you give the right to the put buyer to sell the ETF at the strike price at any time before expiration. That is the opposite position of purchasing puts, but similar to buying calls. You want the ETF to rise or stay above the strike price.

Using our example, if you sell the Dec 80 put for $4, you never want the ETF to go below $80 before the put expires in December, or at least not below the break-even point of $76. If that holds true, you would profit $4 on every put you sell. However, if the ETF drops below the break-even price, you would start to incur losses on every put that is exercised.

Again, it is important to note that selling options brings more risk than buying options. That is not to say it isn’t potentially profitable. The cost of that risk is factored into the price of an option. But if you are a beginner in the world of calls and puts, buying ETF options is the safer route.

Special Considerations

The amount of options trading volume is a key consideration when deciding which avenue to go down in executing a trade. This is particularly true when considering indexes and ETFs that track the same, or similar, security.

For example, if a trader wanted to speculate on the direction of the S&P 500 Index using options, they have several choices available. SPX, SPY, and IVV each track the S&P 500 Index. Both SPY and SPX trade in great volume and in turn enjoy very tight bid-ask spreads. This combination of high volume and tight spreads indicate that investors can trade these two securities freely and actively.