ETFs For Covered Call Writing On Emerging Markets And Gold

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

Many exchange traded funds track a specific index, allowing you a low-cost way to trade the index. Take IWM, for example, which represents an ETF that is made up of two thousand stocks that make up the Russell 2000. When you purchase IWM you are buying a basket made up of two thousand stocks. Other popular ETFs include the S&P 500 (symbol SPY) and the NASDAQ 100 (symbol QQQQ). And there are ETFs to track specific commodities, sectors, or countries. For example, EWZ tracks Brazil, EWJ tracks Japan, XLF tracks financial stocks, and GLD tracks gold bullion.

GLD is an interesting one given everyone's interest in owning gold. But one negative is that GLD doesn't pay cash dividends. However, by using covered calls you can generate recurring income from gold, too. Buy a gold ETF and write calls (at-the-money if you're neutral on gold, or out-of-the-money if you're bullish on gold). GLD is the most liquid gold ETF and definitely the best bet for covered call investing. UGL is two times leveraged and therefore quite volatile, and DGL has very small open interest.

Everyone needs some exposure to emerging markets for diversification. But emerging markets information is hard to come by, inconsistent, and in a format that is difficult to digest. So it's another good case for ETFs. The most popular emerging market ETF is EEM (iShares MSCI Emerging Markets Index Fund), which has nearly $41 billion in assets and is highly liquid. Another choice, if you want to limit your exposure to just China, for example, would be to use iShares FTSE/Xinhua China 25 (FXI).

There is one kind of ETF that you do not want to get involved with for covered calls, and those would be the leveraged ETFs. Leveraged ETFs are designed to be 2 or 3 times more volatile than an unleveraged ETF. You can normally recognize leveraged ETFs because they have words in their names like "double", "2x", "ultra", "triple", "3x", or "leveraged". Leveraged ETFs are most commonly used as short term trading vehicles for day traders and are not appropriate for income-oriented covered call investors. It can be tempting to do a covered call on one of these because the option premiums are usually very high. But there's a reason for those high premiums! Leveraged ETFs are, by definition, 2x or 3x more volatile than their unleveraged counterpart.

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