Covered Calls On Gold And Emerging Markets Using Exchange Traded Funds

An exchange traded fund (ETF) is a basket of securities that trades like a single stock. Many ETFs come with options available so investors can use them for covered calls. They make sense for covered calls because of the inherent diversification they provide (important for smaller accounts). Because of the way they are constructed, there is no single stock risk. If one of the stocks that makes up the ETF drops dramatically then the effect will be felt less by the ETF that contains that stock than by the stock itself.

ETFs that track specific indexes allow you an easy way to trade the index. For example, the Russell 2000 index can be traded through the ETF with symbol IWM. There are two thousand stocks in IWM so by definition it has no single-stock risk. Other popular ETFs with many constituent components include QQQQ (NASDAQ 100) and SPY (S&P 500). Or, if you want something that follows specific sectors, countries, or commodities, you can do that with ETFs, too. For example, XLF tracks financial stocks, EWJ tracks Japan, EWZ tracks Brazil, and GLD tracks the shiny yellow metal.

The ETF with symbol GLD is an interesting one given the interest from investors in owning gold. However, GLD doesn't pay dividends. But, by using covered calls you can create dividend-like cash from gold, too. Just buy a gold ETF and write calls (in-the-money if you're neutral to bearish on gold or out-of-the-money if you're bullish on gold). GLD is by far the most liquid (meaning, most capital invested, and most highly traded) gold ETF and probably your best bet for covered call trading. Other ETF choices include DGL which has small open interest, and UGL which is 2x leveraged and therefore quite volatile.

Much like gold, investors should always have at least some exposure to emerging markets for better diversification. That is especially true considering the volatilities in the forex markets. But emerging markets information is inconsistent, difficult to come by, and in a format that is difficult to understand. So it's another good case for ETFs. The most common emerging markets ETF is the iShares MSCI Emerging Markets Index Fund (EEM), which has nearly $40 billion invested in it. It is highly liquid, which is an attribute you want to see when investing in general, and specifically when writing covered calls. Another choice, if you want to limit your exposure to just China, perhaps, would be to use iShares FTSE/Xinhua China 25 (FXI) instead.

Despite all the positives of using ETFs for covered calls, there is one kind of ETF that you should not get involved with, and those are the leveraged ETFs. They are 2 or 3 times more volatile than a their unleveraged counterparts. You can spot leveraged ETFs because they almost always have words in their names like "double", "2x", "ultra", "triple", "3x", or "leveraged". People who day trade love leveraged ETFs. Good for them. But that does not mean they are appropriate for covered calls written by conservative income-oriented investors (they're not!). They can be tempting because the high premiums they offer. But the extreme volatility is the reason for those high premiums! Better to stick with unleveraged ETFs for selling covered calls.

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