Mr. Kadavy has answered the following questions from readers that may be helpful to others. If you have a question, please use the "E-mail Me" button above. Answers will be provided by return e-mail and, if applicable to a broad cross-section of readers, will be posted to this page:
EXCHANGE TRADED FUNDS
Q. Why do the option premiums on ETFs (Exchange Traded Funds) seem to be less than premiums for options on individual stocks?
A. ETFs are funds containing baskets of stocks (some contain thousands, some only a relative handful). Since a group of stocks inherently has less volatility than most individual stocks, the premiums for options on ETFs tend to provide smaller returns than individual stocks of like kind because volatility is a key component of what determines option premium prices. An ETF consisting of high beta stocks (e.g., technology stocks) however may well offer greater premiums than an individual low beta stock that has little volatility (eg., a food company stock). ETFs containing stocks with greater overall volatility will provide greater option premiums than ETFs containing lower beta stocks. For example, an ETF consisting of technology or biotechnology stocks would provide greater option premiums than an ETF consisting of consumer staples or bank stocks).
Q. When should I use options on individual stocks vs. ETFs for my option writing?
A. The answer to this question depends on several factors: how knowledgeable an investor you are; how much time you have to devote to individual stock selection; how interested you are in researching individual companies. For someone who knows little about the market but wants to invest in equities and employ option writing strategies, ETFs would definitely be the way to go. The number of ETFs offered is growing very quickly, as is the number of ETFs on which puts and calls can be written. Now there is something for everyone (ETFs ranging from sector funds such as biotechnology, retail, banks, etc. to broad index based funds containing a fully diversified portfolio). Some investors who are knowledgeable about certain sectors of the market may choose to use ETFs to fill in their portfolios when they are not knowledgeable about another sector.
Q. Is there such a thing as option writing on bond ETFs?
A. Yes. There are a number of ETFs that consist of bonds on which options can be written. For example, the iShares GS $ InvesTop Corporate Bond Fund (ticker symbol LQD) and the iShares Lehman 7-10 Year Treasury Bond Fund (ticker symbol IEF) are two bond fund ETFs on which options can be written. Since bond funds will typically have very low volatility, option premiums are considerably smaller than premiums on stock ETFs.
Q. How many ETFs are there? As an investor, how can I keep up with them and how can I know which ones offer options for put and call writing?
A. The number of ETFs offered in the U.S. has exploded exponentially, with almost 1,000 ETFs currently available with a combined market value of over $1/2 trillion (compared with $15.6 billion in 1998). Options are available on hundreds of these ETFs. An investor can go to the Bloomberg Web site home page, www.bloomberg.com, click on “EFTs” and then click on “ETF Screener.” You will find access to all ETFs and their ticker symbols. The symbols can then be looked up through your discount brokerage account to see if calls are offered on them.
