Options and exchange traded funds are invaluable tools for
increasing profits, furthering diversification and hedging.
They're especially useful in the metal sectors, and funds like
the iPath Dow Jones-UBS Copper (
JJC
,
quote
), the iShares Global Materials Sector (
MXI,
quote
) and the Globe X Aluminum ETF (
ALUM
,
quote
) have strong connections to emerging markets.
China is already the world's largest consumer of copper, iron ore
and aluminum. India and Indonesia are also increasing their
use of these metals. A very effective way to profit these
growing appetites is to write covered call options on exchange
traded funds that allow it.
Writing a covered call option means selling the right, but not
the obligation, to buy the ETF at a set price within a specified
time limit. The writer of the call options can sell
all or part of the holdings. This allows for some of the
position to sold while profiting on the rise in the rest, all the
while earning premium income from the option.
Covered call options are particularly useful for range-bound
exchange traded funds. If the ETF pays a dividend,
the owner of the call option receives it. If the
option expires, as the great majority do, the owner does not
have to sell the shares and keeps the premium income and any
dividend payments.
One of three things will happen if you write covered call
options:
- The ETF price remains flat, the call options expire, you
keep the premium money.
- The ETF falls in price, the call options expire, and
you keep the premium money.
- The ETF rises to the strike price, the call option is
exercised, you earn the premium income along with any capital
gains.
Dividends paid during any of the three scenarios are retained
by the owner.
Writing covered call options increases the income of an ETF
while providing a hedge. Limit prices should be set to
protect a position and minimize trading costs. Some
recommend a strike price of around 10% to provide a solid balance
of risk and return.
While not all ETFs are optionable, the metals funds described
above provide diversification while increasing investment returns
from growing emerging market economies.