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Options and ETFs

If options are used individually they carry a great degree of risk. However, investors own assets that are optioned, this risk level is greatly alleviated. In the ETF field, options represent a great tool for protection of holdings.

Options can be used for the purpose of locking in profits that have been acquired through a recent run-up. This is done even without the selling of the ETF and thus doesn't represent a taxable event. Options can be also used as a measure against a declining or turbulent market. There are approximately 70 ETF options available now on the open market. However, you should avoid engaging in too many options since you will incur high expenses and a lot of paperwork to keep track of.

Options represent the right to buy or sell a particular stock at a certain pre-determined time. Options are freely traded on the open market as individual stocks are but under different rules. Their value is determined by the value of the underlying stocks and the time left until the contract expires.

The buying (also known as call) has a speculative character. The reason for this is the possibility of the option expiring at no value for the value. However, the vice versa can also happen, meaning that the price of the stock may rise drastically. On the other hand, the selling of calls is described as conservative, especially when the investor who holds the call is covered. Since the investor cannot know for sure the level up to which the underlying stocks will increase, the selling of uncovered options carry a high degree of risk.

The selection of the appropriate course of action depends solely on the level up to which the ETF will increase when the expiration date of the contract comes. Under normal market conditions, an investor looking for a consistent stream of income should select covered call.

However, covered calls have their disadvantages. They are observed when there is a severe down in the market and the investor fails to recognize it. Only a certain level of protection is provided in the case of a bearish investing. Unfortunately, a big portion of any sharp rises in the ETF may be eliminated under covered call conditions, which leads to missed profits.

If you are looking for a steady protection against loss of your assets, then it is advisable that puts are obtained for the ETF under possession. If the strike price is reach at any point in time, the investor has the possibility of unloading the ETF. The put is characterized as speculative when it is purchased alone because it may decrease to such an extent until the contract expires that it becomes with no value for the investor. On the other hand, it is characterized as an insurance if it is purchased as an extension to an existing position in an ETF.

You should consider purchasing a put only if you are afraid that you may incur losses over a short period of time. The repetitive use of options can lead to increased expenses. The complete selling of an option is recommended if the investor is bearish oriented over the long term.

You should also have in mind that transaction fees are paid, but they are justified if the fees that are incurred by the selling of an entire existing position are greater. Options tax rules cannot be classified as either beneficial or unbeneficial. On the one hand, no low long-term tax gain rates are applied to the income that is generated from options, whereas they can be used to offset and capital gains that are acquired by the selling of an existing position.

Thus, you should study carefully both the positive and negative aspects of options and use them when the circumstances call for it.

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