Hedging Tips for ETF Traders

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May 12, 2009 12:47pm ETF BASIC NEWS

hedging2Fans of exchange-traded funds are, by and large, a pretty risk-averse group. By using ETFs, they’re buying bigger chunks of the market, enjoying low fees, and generally riding Wall Street’s larger, more stable waves rather than less predictable ripples in individual stocks. More and more, though, active traders are using ETFs to jump in and out of the market. They’re also adopting some of Wall Street’s tried-and-true risk management strategies to hedge against the market’s wilder swings. Below, we look at a few popular hedging strategies that fit nicely with ETFs, including tools like options, sector funds, and one popular and unique instrument, the leveraged ETF.

Let’s start with options. Today, options are available on only about 40 percent of exchange-traded funds and exchange-traded notes, although the percentage is higher for most popular equity indexes. Aside from limited availability, options on ETFs operate in much the same way as stocks. A word of caution: Options aren’t for everyone. If you’re unfamiliar with the concepts, check out options basics from Investopedia, including definitions of some key terms like call options and put options.

Options 1: “Covered call” or buy/write strategies. Among the most common options strategies used by ETF traders, the buy/write strategy works like this: You buy shares of an ETF and then sell (or write) “call options” on the same shares at a higher price (as with stocks, one option is sold in blocks of 100 shares).

Full Story: http://www.usnews.com/articles/business/investing/2009/05/12/hedging-tips-for-etf-traders.html

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