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Trading ETFs and ETF Options

Once you have chosen the Exchange Traded Funds (ETFs) that are right for your portfolio and market outlook, you are ready to purchase shares of the ETFs. To do so, you can use a full service or discount/online broker in the same way you would to purchase stock shares. Generally, you are able to use the same order types as you would for a stock purchase or sale, including market, limit, stop, stop limits, day and good til cancelled (GTC) orders.

The purchase of ETFs can be executed in either a cash, margin or registered account. If you are considering using options as part of your strategy, the transactions will have to be done either in a margin or registered account. If you plan on selling ETFs short, those trades must also be done in a margin account.

Short Selling of ETFs

Selling an ETF short means that you sell the ETF without actually owning it. You would do so if you anticipate that the underlying index of the ETF is going to decline. You collect the proceeds from the short sale, and when the ETF does decline in price, you would buy the shares back, thereby closing your short position. Your profit would consist of the sale proceeds minus the purchase costs and commissions. If the ETF does not decline, however, at some point you will have to buy the ETF back in order to close your position, and can incur a significant loss by having to purchase the ETF at a higher cost than the original sale.

Trading Options on ETFs

Another method for diversifying and hedging your ETF holdings is to invest in options on ETFs.

There are two types of options - calls and puts.

  • Calls give the holder (buyer) the right, but not the obligation, to purchase that ETF at a specific price (the strike price) within a limited period of time (til expiration).
  • Puts give the holder (buyer) the right, but not the obligation, to sell that ETF at a specific price within a limited period of time.

For example, let's say you are bullish on the S&P/TSX 60 Index over the next five months, and wish to use an ETF option to take advantage of a rise in the index. This table shows the strategy you could use with an ETF tracking this benchmark index (symbol XIU):

The benefit of buying an ETF call option, instead of purchasing the actual ETF, is that you will have less capital at risk. The downside is that you can lose your whole option investment; however, it could be less compared to what you might have lost had you bought the actual ETF units in full.