While the trading and tax advantages of ETFs are typically well known, the ability to trade options on an ETF is an underutilized benefit of these flexible funds. Option strategies are typically reserved for professionals, but I’ll run through a few basic strategies below that can be implemented by anyone investing in ETFs.
Basic option strategies may be used to manage risk and/or enhance income in an investment portfolio. These strategies are built with put and/or call options.
A put is an option contract that gives the owner the right, but not the obligation, to sell a specified amount of an underlying asset at a set price within a specified time. The buyer of a put option estimates that the underlying asset will drop below the exercise price before the expiration date.
A call option is the flip side. It gives the owner the right, but not the obligation, to buy (under the same conditions above). The buyer of a call option estimates that the underlying asset will rise above the exercise price before the expiration date.
So why use option strategies with ETFs?