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Aug 17, 2016

Trading ETFs in Smaller Accounts

By:Sage Anderson

If you are new to options trading, one great place to get acclimated to the industry is through Exchange-Traded Funds (ETFs).

ETFs are securities that track an index or a basket of assets. Unlike mutual funds (which are similar in some ways), ETFs trade like common stock on an exchange. ETFs also have more liquidity and lower fees than mutual fund shares, contributing to their popularity.

One of the reasons that ETFs represent a great starting point in the world of options trading is due to their differing risk profile as compared to individual stocks.

Individual stocks and their associated options carry two kinds of risk - risk to the specific stock (unsystematic risk) and risk to movements in the broader market (systematic risk). ETFs, which invest in a variety of companies, face reduced company-specific risk due to increased diversification.

For example, a trader that sell puts in Exxon Mobil (XOM) faces a great deal of company-specific risk. On the other hand, a trader that sells puts in XLE (Energy Select Sector SPDR) is exposed to not only XOM, but a great deal of other companies in the energy sector.

If XOM announced negative news, the stock may drop precipitously. Under that scenario, XLE would also be affected, but to a lesser degree.

A recent episode of Tasty Bites examined some additional reasons that ETFs can be such a great place for new options traders and/or those trading smaller accounts.

As already noted, ETFs have reduced exposure to unsystematic single-stock risk, but they also have lower notional values when compared to futures and/or index options, and offer greater diversification.

Reduced exposure to unsystematic risk also means that ETFs usually trade with lower implied volatility, as shown below:

Research presented on this episode of Tasty Bites also suggests that ETFs tend to stay within their expected move more frequently than individual stocks.

If you do decide to trade ETF options, we recommend sticking to some bedrock tastytrade principles - as outlined in this piece "Twenty tastytrade Trading Commandments” - just as you would with individual stocks.

The following are some examples from the ETF sector that may offer opportunity for you to deploy risk in a fashion that meets your capital requirements and risk profile: Russell 2000 (IWM), S&P 500 (SPY), Nasdaq (QQQ), Bond ETF (TLT), Oil Services (XLE), Oil Exploration (XOP), Metals and Mining (XME), Gold (GLD), Silver (SLV), and Emerging Market (EEM).

For additional information on any of the above ETFs we encourage you to leverage the search functionality on the tastytrade homepage, or reach out directly at support@tastytrade.com.

We look forward to hearing from you!

Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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