In August, nearly one-third of all market trading volume involved exchanged-traded funds. The popularity of ETFs — baskets of funds that focus on a certain sector, index or country — has never been higher.
However, the same goes for volatility, which is off its peak levels of last month but continues to be well above longer-term averages.
It makes sense, then, to use options to maximize as much profit from an ETF trade as you can, while lowering your risk.
Here are four ETF-focused trades that could pay off:
Buying XLF Puts, Buying SKF Calls
Recommended by: Michael Shulman, Editor, Options Income Blueprint
The run — by traders, not customers — on U.S and European banks is not over, and it won’t be over until the banking crisis in Europe and the recession in the U.S. are over — so this trade you can work for a long time.
Rather than picking winners and losers, focus on one of two trades, depending on your appetite for risk — buying puts on the Financial Select Sector SPDR (NYSE:XLF) ETF or, the ETF for the banking sector or buying calls on the Proshares UltraShort Financials (NYSE:SKF), the double-inverse ETF on the U.S. banking sector.
- See also: 4 Reasons to Trade ETF Options
The XLF tracks one-for-one the performance of the financial sector, both money center and investment banks. The SKF tracks daily movements in the financial sector, which means over a long period of time it may not move as far and as fast as the underlying sector — or it may move faster and further. Bank earnings are due to come out in mid-October, and they are expected to be weak.
The real issue will be forecasts for the fourth quarter and 2012 — and these will be weaker than currently anticipated, since the Street still doesn’t think we’ll be in a recession – even though we’re already in one.
Other potential catalysts include potential Federal Reserve actions that eliminate the interest the Fed pays on cash the banks have on deposit at the Fed and an “event” in Europe of unknown shape. Look at positions past October earnings — November and beyond. And if you also believe that banks are going to take hits for an extended period of time, look at LEAPs for this coming January — or January 2013.
VXX Bear Call Spread
Recommended by: Tyler Craig, Tyler’s Trading
As we continue to distance ourselves from the early August crash, the market has settled down noticeably. This “return to normalcy” has been reflected in a number of volatility indicators such as average true range and historical volatility. Traders looking to bet that volatility will continue to diminish have a variety of intriguing strategies to choose from.
If the current correction is approaching its conclusion, the iPath S&P 500 Short-Term Futures ETN (NYSE:VXX) should begin to fall from its lofty heights. One approach worth considering is selling out-of-the-money October or November call spreads on the VXX. The Oct 50-55 call spread currently offers a 75-cent credit — or a 17% return if VXX remains below $50 between now and the October expiration. To enter the position, traders would sell to open the 50 call option while buying to open the 55 call option.