This is a weekly column focusing on ETF options by Scott Nations, a proprietary trader and financial engineer with about 20 years of experience in options. Investors know that if the ETF they own has rallied, they can sell it and book a profit. Savvy investors know they can buy protective put options on their ETF. While they might lose the difference between where their ETF is trading now and the strike price of their option, that strike price is an absolute floor, although they also have to pay for their put option.
The savviest investors know they can sell their ETF shares now and use a tiny portion of the proceeds to buy call options as a replacement. These call options will allow the investor to participate in any additional upside, while making certain they get what the ETF is trading for currently, although they also have to pay for their call option. Our trader is worried about a sell-off in SPY, and wanted to lock in gains or stem any loss—hence selling the shares.
This potential underperformance is the real cost of a stock replacement trade. Making money is difficult enough. Follow Scott on Twitter ScottNations. View the discussion thread. But who does the move benefit? Among the many volatility exchange-traded products, a small and relatively young strategy is leading the giants.
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