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.
Trading Options on Commodity ETFs
In the past, investing in commodities was mostly limited to the futures markets. But now, ETFs offer investors easier 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 can buy or sell both call options and put options that trade in blocks of 100 shares of the underlying ETF.
If you’re having a hard time finding ETF’s 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 good commodity ETF’s to trade options because there aren’t that many, as you may have seen.
First, the majority of commodity ETF’s don’t have options, period.
Second, of the commodity ETF’s that do have options, most lack enough volume to trade options efficiently. 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.
Simply type the ETF’s symbol, such as “SLV”, at Yahoo Finance or the NASDAQ website. Then click on the “Options” tab to 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 are not easy to come by, let me share three of the best commodity ETFs to trade options. Each of these ETFs are actively traded and have an active options market as well.
Blackrock’s iShares Silver Trust is one of the most widely held commodity ETFs, with just under $7 billion in assets under management. SLV provides direct exposure to silver by investing in silver bullion which is held in vaults in London.
Share values equal the spot price of silver (minus fund expenses). By investing in physical silver, the fund avoids the risks and complexities associated with trading silver futures.
One cautionary note: SLV receives unfavourable tax treatment as a collectible, thus subject to a tax rate of up to 28%, considerably higher than the average capital gains rate.
However, as the largest and most liquid ETF in its category, traders benefit from very low bid/ask spreads. This is key for traders looking to use ETF’s to trade commodity options.
The 60-day average bid/ask spread is a mere 0.06%, something any trader would love. Average daily trading volume is $397 million.
iPath Series B Bloomberg Cotton Subindex Total Return ETN (BAL)
For investors looking for exposure to one of the oldest and most widely traded basic commodities – cotton – there’s the Bloomberg Cotton Subindex Total Return ETN. It aims to track the Bloomberg Cotton Index, which is comprised of a single cotton futures contract anywhere from one to five months from maturity.
Because this ETF only holds a single futures contract at a time and only invests in the front or nearby month contracts, potential problems of contango are largely avoided. That is, the futures price traded is not likely to differ widely from the spot price.
The index’s contract selection is guided by liquidity and the life cycle of the cotton plant – during harvest season, it holds a more nearby contract, only one or two months out.
Should you end up holding this ETF for any length of time, the expense ratio for BAL is attractively low at 0.45%. This fund, issued by Barclay’s in 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 ETFs with available options to trade it. It’s worth noting that the Invesco Water Resources ETF scores high – 7.59 out of a possible 10 – on the MSCI ESG Ratings Service that helps investors evaluate environmental, social, and governance investments.
PHO tracks the NASDAQ OMX US Water Index, a liquidity-weighted index of US-listed companies engaged in the business of water conservation and purification. Its focus is on mid-cap and small-cap firms, with only about 10% of its portfolio dedicated to large-cap companies.
Primary holdings include Danaher (which recently acquired GE’s biopharma unit), Roper Technologies, and Tetra Tech (a major environmental and resources consulting firm).
It’s the most widely held and liquid of the handful of water-focused ETFs, with $1.02 billion in assets and an average daily volume of $2.4 million. Again, should you own PHO for any length of time, it’s worth noting the expense ratio is a modest 0.60%.
Summary for Best Commodity ETF’s to Trade Options
The best commodity ETFs to trade options on are, first of all, good ETFs period. If trading the underlying ETF isn’t a good idea, then trading options on it likely won’t fare much better.
Important trading factors to look at are liquidity and how well a particular ETF represents its underlying commodity. These three commodity ETF’s meet this criterion well.