Investing Adventures

Tuesday, November 6, 2007

Index and ETF Series Recap

Filed under: Index and ETFs, Options — Jorge @ 5:28 am

So far, here’s a recap of the indices and ETFs we’ve covered so far:

We’ve covered indicies and ETFs for the broader market.  This week, let’s go ahead and hone in on some specific sectors.  With the credit crisis out there, it may be valuable to explain the XLF ETF.  With oil eying $100 a barrel, let’s go ahead and look at the OIH and the XLE ETFs this week as well.  Finally, we’ll round out the week with a goodie, the EEM, or the emerging markets ETF.  Foreign exposure at this point may be necessary if the US economy is in a rut (and not the RUT ETF)!

Saturday, November 3, 2007

iShares Russell 2000 (IWM) – Index and ETFs for Options

Filed under: Index and ETFs, Options — Tags: — Jorge @ 12:00 am

A quick recap of the previous indices and ETFs used by options traders include:  the QQQQ, the SPY, and the VIX.  Today we’ll give you some small-cap exposure with the iShares Russell 2000 ETF known as the IWM.

What is the IWM:  The IWM attempts to track the performance of the 2000 smallest companies found on the three major exchanges, the NYSE, the AMEX, and the NASDAQ.

Why use the IWM:  If you’re interested in gaining small-cap exposure, the IWM is the tool for you!  If your outlook is bright with small-cap companies, using options may be a cost effective way to gain exposure through the IWM.  A caveat of the IWM is that each year around July 1st, the Russell 2000 revises its members.  Any companies that have grown are bumped into the Russell 1000 (the largest 1000 companies on the three major exchanges).  Companies that have decreased in size from the Russell 1000 may be reintroduced into the Russell 2000.  Keep an eye out each year for any changes.  Some of your favorite stocks may have grown up and moved on to better pastures.

IWM Options Structure:  The IWM trades similarly to the SPY and QQQQ with $1 strike prices and $0.01 bid/ask spreads.  Liquidity, with the other largely traded indices and ETFs, is almost a non-issue.

The IWM is great for small-cap exposure for your portfolio.  In a growing economy I could see the IWM performing well or perhaps outperforming some of the other major indices.  If you’re looking for a more risky position, take a look at some options contracts on the IWM.  You won’t be disappointed!

Friday, November 2, 2007

Volatility Index (VIX) – Index and ETFs for Options

Filed under: Index and ETFs, Options — Tags: — Jorge @ 12:00 am

Yesterday I showed you a useful tool in hedging your options portfolio, the SPDR S&P 500, or the SPY (spyder trust). So far we’ve gone over how to gain broad market exposure with the largest 100 companies in the NASDAQ and exposure to the S&P 500, two important indices for options traders. Today we’ll look at an index that isn’t as simple to understand, the CBOE Volatility Index, or the mighty VIX.

What is the VIX: The Volatility Index, or the VIX, is a measure of fear within the markets. How an index can determine fear is beyond me, but it’s there. The VIX measures the implied volatility found in the S&P 500 index options. It’s currently measured in percentages with anything under 20 representing complacency in the options market while anything around 25 and above represents a potentially volatile environment.

Why use the VIX: I’ve never traded the VIX but I could only assume options traders purchase and sell contracts on the VIX as a way of hedging against or gaining exposure to volatility. Volatility is what gives options the lifeblood they need to make successful trades. The more volatile the market, the better chance an options trader has of making successful trades. Recession talks, rising commodities prices, or any other major events could swing the VIX one way or another and it is possible to gain exposure of that volatility through VIX contracts.

VIX Options Structure: The VIX trades at $1 increments with a $0.05 bid/ask spread. The VIX does not represent actual dollar amounts but contracts trade as such. Remember that the VIX is a percentage value on the overall volatility of the S&P 500.

The VIX helps to determine the implied volatility of the S&P 500 index options. It helps to predict movement in the S&P 500 over the next 30 days through a fairly simple mathematical formula. The following was taken from Wikipedia:

Assuming the VIX is reading 18.53%. Using the formula VIX % / sqrt (12 months), we can predict with about a 68% certainty, the S&P 500 will move either 18.53/3.464 % up or down, or 5.35% over the next 30 days.

The VIX is a simple but useful tool in determining the overall volatility of the market. One can argue that the VIX does not determine individual sector volatility. In any event, it gives a simple view of the volatility in the market and can be used to an option trader’s advantage. The higher implied volatility climbs, the higher option premiums become and as a result gains (and losses) can be greater. If you’ve ever traded an option prior to some breaking news (earnings report, press release), I’m sure you’ve noticed the day after the news has been released, almost always the options price drops. That’s a result of a drop in implied volatility. The VIX can help figure out the overall implied volatility of the market. Don’t forget to check in with the VIX every day!

Thursday, November 1, 2007

SPDR Trust (SPY) – Index and ETFs for Options

Filed under: Index and ETFs, Options — Tags: — Jorge @ 12:00 am

Last time we discussed the Powershares QQQ (Symbol: QQQQ) ETF and how options trading uses it for broad exposure to movement in the NASDAQ. Today let’s discuss another widely used ETF, the SPDR S&P 500 ETF, otherwise known as the Spyder (Symbol: SPY).

What is the SPY: The SPDR S&P 500 SPY attempts to track the broad S&P 500 index. All equities found in the S&P 500 are found in the SPY ETF.

Why use the SPY: If you notice, the SPY has approximately one tenth the value of the S&P 500 index making it an attractive vehicle to purchase options with for broad based market exposure. The key to the SPY is that most hedge fund managers and others on Wall Street base their performance on the performance of the S&P 500. The SPY, therefore, makes an important tool for hedging portfolios against any drop in the S&P 500 benchmark. From the data I’ve gathered, the SPY is used primarily for hedging but can be used in a bullish sense as well with the S&P 500.

SPY Options Structure: As with the QQQQ, the SPY options are on a $1 strike price interval and trade with as close to $0.01 bid/ask spread.

The SPY is used mainly as a hedge against a dip in the S&P 500. Normally, the SPY is traded in a put options spread limiting rewards but also limiting risks in the event the market maintains a bullish view. As an example, today’s SPY put options had similar volumes at the $150 and $153 strike prices. Using a trade calculator found on OptionsXpress, if one were to purchase a put at the $153 strike price and sell the $150 put, the resulting trade at expiration would create a profit up to $233 per spread traded if the market were to drop below approximately $151 with a potential loss of $67 anywhere above $152. In other words, if the S&P 500 were to correct about 30 points tomorrow, your portfolio would take a hit but would recover some loss through the SPY spread trade.

In my opinion, the SPY should be an integral part of any options trader’s portfolio. With the above example, turning a $67 insurance policy into a $233 payout for downside protection will help you sleep at night.

Wednesday, October 31, 2007

Powershares QQQ – Index and ETFs for Options

Filed under: Index and ETFs, Options — Tags: — Jorge @ 7:39 am

Index and ETF options are one of the weapons an options trader has in capturing broad exposure to certain situations whether it’s the broad S&P500 index or the financial sector. In this series, I’ll explain some of the more common index and ETF option contracts options traders have access to and wield rather frequently. As always, if there’s an index or ETF you’re not sure about and would want a better explanation, feel free to drop me an e-mail or a comment and I’ll be sure to add it to the running list.

Today’s index / ETF is the Powershares QQQ (Symbol: QQQQ), the most actively traded index / ETF in the world according to Powershares.

What is the QQQQ: The QQQQ attempts to track the performance of the 100 largest non-financial companies on the NASDAQ. Top holdings in the QQQQ include Apple, Microsoft, Google, Research in Motion, and eBay to name a few.

Why use the QQQQ: The QQQQ helps diversify a portfolio by covering a large number of companies without having to purchase contracts (or shares) for each individual company (as is common with most index / ETFs). Similar to the Forex (currency) market, the liquidity for the QQQQ is almost a non-issue with open interest around the 1 million mark. The QQQQ can be used as a hedge to the NASDAQ due to the large number of companies included in the ETF.

QQQQ Options Structure: The QQQQ trades just as any other equity trades on the options market. The QQQQ trades in $1 strike increments with options trading in penny increments. This offers great flexibility and inherently lower costs since the bid / ask spread is not as large as most options contracts. Most options contracts trade with a $0.05 to $0.10 bid /ask spread and as such can cut into profits.

If you want broad exposure to the large companies listed on the NASDAQ, the QQQQ may be for you. In the past year, the QQQQ has increased over 25% in price as compared to about 20% for the NASDAQ index so the tracking attempts by the ETF are almost on the mark.

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