If you are feeling comfortable with your current approach, but are looking for additional diversification in your portfolio, you might consider international exchange-traded funds (ETFs).
This slice of the ETF world is comprised of securities that are exposed to a particular region of the world, or a group of international companies with a similar profile.
For example, the iShares China Large Cap (FXI) is composed exclusively of large-cap companies with direct exposure to the Chinese economy. On the other hand, the iShares MSCI EAFE (EFA) is comprised of large and mid-cap companies operating in a variety of developed countries around the world (excluding the US and Canada).
Just like the SPY, which is exposed to the performance of 500 American companies, these international ETFs offer long and short premium opportunities depending on market conditions and your unique trading approach.
If you are hypothetically short premium the SPY because you think that implied volatility is too high, then a long premium trade in EFA may offer protection against your SPY trade - especially if EFA screens cheap in terms of Implied Volatility Rank (IVR), or another metric you rely on.
Alternatively, you may be looking to add additional short premium exposure to your portfolio that offers diversification beyond American companies. For example, if you're already short premium in the SPY, you may not want to add additional short premium in Goldman Sachs (GS) because it is already a component of SPY.
Instead, you might decide that your short premium trade in SPY, which is comprised of large and mid-cap companies in the United States, might be better paired with a short premium trade in EFA, which is comprised of large and mid-cap companies in other developed countries (excluding the US and Canada).
From this standpoint, a trade in EFA diversifies the exposure in your portfolio by spreading it across a higher percent of the world economy (not just the USA), and a larger pool of companies. A recent episode of Market Measures focuses on international ETFs and may be of interest to traders considering such products.
On this installment of the series, the team looks at the expected and actual moves in four highly liquid international ETFs (EFA, EEM, FXI, and EWZ). Conducting a historical analysis in these four symbols, the team evaluated whether implied volatility tends to be overstated, as has been observed consistently in SPY.
The results, using data from 2011 to present, are shown below:
As you can see from the above, data from this period supports the notion that implied volatility tends to be overstated in international ETFs. Looking at the results, EFA, EEM, FXI, and EWZ all had smaller actual moves than what was expected based on implied volatility.
This information does suggest there may be opportunity to be found in international ETFs, assuming these products fit your approach and risk profile.
We hope you'll review the complete episode of Market Measures focusing on expected versus actual moves in some well-known international ETFs when your schedule allows.
If you have any questions related to this material, or any other trading topic, please don't hesitate to contact us at firstname.lastname@example.org.
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.