When investors first enter the realm of securities trading, they typically stick to buying puts and calls on stocks. However, stocks are not the only securities on the NSE.
ETFs differ from traditional mutual funds. Traditional mutual funds take orders during market trading hours, but the transactions actually occur at the close of the market.
Option markets for individual companies, except for a very few extremely active stocks, often have large spreads between the bid and asked price.
In many cases, a single market maker sets the prices, and it is difficult to get good executions when you trade.
The Nairobi Securities Exchange (NSE) #ticker:NSE has introduced a new product in their portfolio - Exchange-Traded Funds (ETFs), which are index funds that trade just like stocks on major bourses.
One ETF could be a group of different stocks or commodities but one buys them in units just like stocks.
When investors first enter the realm of securities trading, they typically stick to buying puts and calls on stocks. However, stocks are not the only securities on the NSE.
Whether you are bullish on energy sector or bearish on banks, there is a good chance that you can find an ETF that aligns with your trading ideas. What’s more, these vehicles allow you to diversify your portfolio, without going through a multitude of stocks, creating a low cost way to reduce risk.
ETFs are derivative securities — derived from other underlying assets — that give traders the right to buy in the form of call options, or sell in the form of put options, a designated underlying security.
A large number of different option contracts with different parameters trade against ETF. In addition, just about every major industry in the world market has an ETF for investors who wish to select an entire industry rather than individual stocks.
ETFs differ from traditional mutual funds. Traditional mutual funds take orders during market trading hours, but the transactions actually occur at the close of the market.
The price they receive is the sum of the closing day prices of all the stocks contained in the fund. Not so for ETFs, which trade instantaneously all day long — just like ordinary stock.
Calls and puts are the most straightforward way to trade options, and the same basic methodologies apply when trading ETF options. Calls allow you the opportunity to buy the underlying ETF at the predetermined price you have regardless of future pricing down the line.
Conversely, puts allow traders to sell the same vehicle in the future at the set price they have selected.
If you trade actively in options, and particularly if you are hedged — meaning that you are putting on many different positions rather than speculating with the simple purchase of puts or calls, it is important to look at the options market for the underlying security.
Option markets for individual companies, except for a very few extremely active stocks, often have large spreads between the bid and asked price. In many cases, a single market maker sets the prices, and it is difficult to get good executions when you trade.
As with any trading vehicle, ETFs and ETF options pose some risks and it’s important to be aware of and manage them. One risk is the same as trading any mutual fund, index or even a stock.
The market can turn and an investor could lose money. The nice thing about ETFs is that, just like a stock, I can set stops and limits and be out immediately. The same goes for options on the ETF.
The main risk I think about when considering ETFs is that I do not know the exact mechanics of that ETF in terms of how it is valued and how it behaves relative to the basket of assets it represents. This can affect the results of an option trade based on that particular ETF.
The main way to manage these risks is to be well educated on the ETF you are trading. Every ETF has a prospectus, so it’s easy to research the ETF to determine if it is one worth trading.
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