Exchange-traded funds – ETFs – have been an increasingly popular investment vehicle ever since their introduction in U.S. financial markets in 1993.They can be used to invest in stocks, bonds, and most other investments, including commodities.
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TradingOptions onCommodity ETFs
In the past, investing in commodities was mostly limited to the futures markets.But now,ETFs offer investorseasier access to commodity investing.
They offer investments in a single commodity,commodity groups, and broad commodity indexes.Options on ETFs operate the same as stock options: investors canbuy or sell both call options and put optionsthat trade in blocks of 100 shares of the underlying ETF.
If you’re having a hard time finding ETFs to trade options, there’s a good reason as explained next.
Problems with Trading Commodity ETF’s
There are a couple of problems I want to mention in finding goodcommodityETF’s to trade optionsbecause there aren’t that many, as you may have seen.
First, the majority of commodity ETFs don’t have options, period.
Second, of the commodity ETF’s that do have options, most lackenoughvolume to trade optionsefficiently. Low volume leads to wide bid-ask spreads which end up costing traders more money.
Verifying Good Commodity ETF’s with Options
If you’re thinking of trading options on a certain commodity ETF, here’s how to quickly check to see if it has options and if a good amount of volume exists based on the bid-ask spread.
Simplytypethe ETF’s symbol, such as “SLV”, at Yahoo Finance or the NASDAQ website. Thenclick on the “Options” tabto see the latest call and put option strike, bid, and ask prices for any ETF option.
Good Commodity ETF’s to Trade Options
Having clarified that commodity ETF’s for options trading is not easy to come by, let me share three of the best commodity ETFs to trade options. Each of these ETFs is actively traded and have an active options market as well.
iShares Silver Trust(SLV)
Blackrock’s iShares Silver Trustis one of the mostwidely heldcommodityETFs, with just under $7billion in assets under management.SLVprovidesdirect exposure to silver byinvesting in silver bullion which is held invaults in London.
Share values equalthe spot price of silver (minus fund expenses).By investing in physical silver,the fund avoids the risks and complexities associated with trading silver futures.
Onecautionary note: SLV receivesunfavorabletax treatmentas a collectible, thus subject to a tax rate of up to 28%, considerably higher than theaverage capital gains rate.
However, as the largest and most liquid ETF in its category, traders benefit from the very lowbid/ask spreads.This is key for traders looking to use ETF’s to trade commodity options.
The 60-day average bid/ask spread isa mere0.06%, something any trader would love. The average daily trading volume is $397million.
iPathSeries B Bloomberg CottonSubindexTotal Return ETN (BAL)
For investors looking forexposure toone oftheoldest and most widely tradedbasic commodities – cotton–there’s the Bloomberg CottonSubindexTotal Return ETN. Itaims to track the Bloomberg Cotton Index, which is comprised ofa singlecotton futures contract anywhere from one to five months from maturity.
Because thisETFonly holds a single futures contractat a timeand only invests in the frontor nearbymonth contracts,potential problems of contangoare largely avoided. That is, the futures pricetradedisnot likely to differ widely from the spot price.
The index’s contract selection is guided by liquidityand the life cycle of the cotton plant– during harvest season, it holdsa more nearbycontract, only one or two months out.
Should you end up holding this ETF for any length of time, the expense ratio for BAL isattractively low at0.45%.This fund,issued by Barclay’sin 2018,has $10.45 million in assets under management and an average daily trading volume of$323k.
Invesco Water Resources ETF (PHO)
There’s no commodity more basic than water, and sure enough, there are niche ETFswith available optionsto trade it.It’s worth noting that the Invesco Water Resources ETFscores high– 7.59out of a possible10–onthe MSCI ESGRatings Service that helps investors evaluateenvironmental, social, and governanceinvestments.
PHO tracks the NASDAQ OMX US Water Index, a liquidity-weighted indexof US-listed companiesengaged in the business of water conservation and purification.Itsfocus is on mid-cap and small-cap firms, with only about 10% of its portfoliodedicated to large-cap companies.
Primary holdings includeDanaher(which recently acquired GE’s biopharma unit),Roper Technologies, and Tetra Tech(a majorenvironmental and resourcesconsulting firm).
It’s the most widely held and liquid of thehandful of water-focused ETFs, with$1.02 billion in assets andanaverage daily volumeof $2.4million.Again, should you own PHO for any length of time,it’s worth notingthe expense ratio is a modest 0.60%.
Summary for Best Commodity ETF’s to Trade Options
The best commodity ETFs to trade optionsonis,first of all, a good ETFsperiod. Iftrading the underlying ETF isn’t a good idea, then trading options on itlikely won’t fare much better.
Important trading factors tolook at are liquidityand how well a particular ETF representsitsunderlying commodity. These three commodity ETFsmeet this criterion well.
