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How (and Why) to Trade Options on ETFs

Money Morning Contributor
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The markets have started the year in a significant nosedive.

In fact, we’ve basically replicated the volatility we saw back in August and September of last year.

Any day that we get a bounce, even a slight one, the pundits start asking if this is the bottom.

And you start wondering where you should put your money.

Fortunately, you don’t have to worry about finding the perfect stock.

There’s a much better way to survive these markets: exchange-traded funds (ETFs).

ETFs Can Remove the Stress from Stock Picking

People get fixated on finding THE best stock in which to invest.

etfs
At one time, high flyers like Priceline Group Inc. (Nasdaq: PCLN), Alphabet Inc. (formerly known as Google Inc.) (Nasdaq: GOOGL), Apple Inc. (Nasdaq: AAPL), and Netflix Inc. (Nasdaq: NFLX) got all the press. This helped financial news networks gain viewership – so long as they could keep those stocks on their screens.

But there are thousands of optionable securities to choose from in all types of sectors and industries.

And trying to find the right one, or the one that will perform the best, is like trying to find a needle in a haystack.

Furthermore, the “right one” is a relative term. What may be right for one investor may not be right for the other.

So instead of going through the daunting task of finding the needle in that haystack, let’s focus on the haystack itself: the ETF.

An ETF is a security that tracks an index, commodity, bonds, or a basket of assets in a certain industry or sector, like an index fund.

ETFs trade just like a common stock on an exchange and experience many price changes throughout the day. Personally, I like them for the diversity they allow.

Here’s an example…

Let’s say you believe in a specific industry like technology. Instead of trying to pick out the best tech stock, you can simply buy the Technology Select Sector SPDR ETF (NYSE Arca: XLK).

Another reason I like ETFs is that they can offer some protection against a risk investors face – a bad earnings report.

As an investor, one of the biggest risks you can face is a bad earnings report. A bad earnings report for a stock can significantly drag down the stock’s price.

However, with an ETF, it may be less susceptible to a decline in price because there are other holdings to offset that one stock. And on a bad day, the ETF holds its value better than the one stock.

Your Golden Rule for Trading Options: Let the Tool Tell You Where to Move

As you know by now, I am an options trader. So I do not advocate investing in anything right now (stock, commodity, or ETF) other than your own education.

But I am inclined to trade options on ETFs, higher or lower.

So which one is good to trade?

My Money Calendar tool researches ETFs like the SPDR S&P 500 Trust ETF (NYSE Arca: SPY), SPDR Dow Jones Industrial Average ETF (NYSE Arca: DIA), and the Select Sector SPDR ETFs (such as the XLK, XLE, and others).

The rule of thumb for trading options on ETFs is no different than it is for trading common stock: Let the tool tell you the average price move over a specific date range and if the expected move will be higher or lower.

Then you’ll want to use your options tool to see if there’s an option that can double in value within that time frame – even if it’s just the average price move that happens again.

A great ETF resource you can use is Select Spector SPDR, which shows you 11 primary sector ETFs of the S&P 500.

You can get an idea of the one sector that is positive for January below:

etf options

As you can see, the utilities industry is the only one that’s positive so far this year.

Now you may believe consumer staples or healthcare will be the first to turn positive, or you may see continued weakness in oil. So tracking the ETF of stocks in an industry in which you work or follow (or both) may be worth your time because of the diversification that’s provided.

Also, tracking them to see where they may be coming up on areas of support or resistance – or breaking out of periods of consolidation – may also be your method of finding an option trade.

Remember that an ETF trades just like a stock, and you will see how similar they look when reviewing charts on ETFs.

So before you stress over finding the perfect stock options, consider ETF options.

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