Writing Covered Calls On Gold And Emerging Markets Using Exchange Traded Funds

An ETF (exchange traded fund) is a collection of securities that trades like a single stock. Many ETFs have options available so investors can use them for covered calls. They make sense for covered calls because of the built in diversification they provide (especially true in 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 dramatically then the effect will be felt less by the ETF that contains that stock than by the stock itself.

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

The ETF with symbol GLD is an interesting one given the interest 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.

To be diversified you will want some emerging markets exposure in your portfolio. But given the difficulty of finding reliable, solid information on companies in other countries, the safer way to play emerging markets is with a basket of stocks in an ETF. The most popular emerging market ETF is EEM (iShares MSCI Emerging Markets Index Fund), which has over $39 billion in assets and is about as liquid as it gets. If you want to limit your exposure to just one country, say China for example, then you can use FXI (iShares FTSE/Xinhua China 25) to write calls against.

There is one kind of ETF that you should absolutely not get involved with for covered calls, and that would be the leveraged ETFs. Leveraged ETFs are designed to be much more volatile than an unleveraged ETF. You can typically identify leveraged ETFs because they have words in their name like "double", "ultra", "triple", "2x", "3x", or "leveraged". Leveraged ETFs are mostly for day traders and are not appropriate for conservative income-oriented covered call investors. It can be tempting because the premiums are usually pretty high. But there's a reason for those fat premiums, so beware! Leveraged ETFs are, by design, two or three times more volatile than their unleveraged counterpart.

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