Hi Mr. Wolfinger:
Your book is incredible. I'm just about geared up to implement a covered call strategy with ETFs. I wonder if contract liquidity plays a role and where I can go to see which EFT’s have options with the most volume? Any suggestions on how to get a bigger picture of contract liquidity? Is it even important?
Thanks for the kind words regarding the book (Create Your Own Hedge Fund).
Yes, volume plays a role. It's much easier to trade when contract volume is high, rather than almost nonexistent. And that's even more true if you decide to close, or roll, a position prior to expiration.
But there is more to the answer. If the bid-ask market is tight, then you can get your order filled at a reasonable price, regardless of volume. The problem is that many of these indexes have so little volume and bid-ask spreads that are so wide that it's almost impossible to get a decent fill. In those situations, selling at the bid price is seldom desirable. All you can do is enter your order at a price you are willing accept and wait to see if it is filled. But that presents a serious problem. If you buy your ETF first (and most brokerage firms will not allow you to sell your call option before you own the underlying stock or ETF) and then enter an option order, that option order may not get filled at your price. Or the market may head lower, in which case you would have no chance to sell your call. Thus, it is far better to adopt a covered call writing strategy using options that have some volume.
By the way, one way to avoid the pitfalls mentioned above is to adopt the equivalent uncovered put writing strategy (as described in the book). If you enter an order to sell the put and if it goes unfilled, nothing is lost - except opportunity. If you own the ETF and fail to sell your call, you would be long the ETF and subject to market risk. If selling puts makes you uncomfortable, then stick with covered calls. If your broker won't allow selling those naked puts, get another broker (deep discount).
There is one other possible solution, but be certain your
broker does not charge an excessive commission to do this for you. You
can enter the buy-write as one order. In other words, you give the
debit you are willing to pay to buy the ETF and sell the call. It's a
combination order - you either get filled on both legs, or neither.
You would not have any risk of owning only the ETF and not being able
to sell the call. Some brokers do that for no extra charge, others
don't. So ask if you can enter that order and still pay online rates
(I assume you want to trade online and not spend the mucho bucks to
speak with a live broker).
To answer the final question - 'is it important?' - the answer is a qualified 'yes.' It's important, but not critical. There are many ETFs which offer options to trade, but the ones with the best volume are the easiest to trade. Because covered call writing is a bullish strategy, you certainly want to only own those ETFs that interest you - i.e., you may prefer large caps, or small caps, or specific sectors, etc. You can, of course, simply choose the ETFs with the best option volume - but ask yourself if you really want to own those specific ETFs.
Here is one place to find ETF volume (not option volume):
Go to www.amex.com
In left-hand column, click on the + sign next to ETFs
In the drop down menu, click on Market Summary
There now appears a table of all the ETFs with volume.
It's likely the more active ETFs have more option volume, but it is no
I have been unable to find a tabulation of volume for ETFs, but the
best advice I can offer is to go the the CBOE site
) and check the open
interest in the last column. The higher the OI, the greater the average
daily volume. FYI, I trade some of those options with little or no
volume, but it makes my life more difficult.
Best of luck and let me know when you get started with this strategy.