HardAssetsInvestor

Written by Brad Zigler  |

May 27, 2008

Options For Options

Details

A lot of people are holding their collective breath awaiting an anticipated May 30 launch of options trading on SPDR Gold Shares (NYSE Arca: GLD). They must be blue by now because it's been a four-year wait as the Securities and Exchange Commission and the Commodity Futures Trading Commission made nice-nice over regulating the instruments. Options trading is also on the horizon for the iShares COMEX Gold Trust (AMEX: IAU) and the iShares Silver Trust (AMEX: SLV).

These launches won't be a watershed, though. Options already trade on the PowerShares DB Gold Fund (AMEX: DGL) and on the PowerShares DB Silver Fund (AMEX: DBS), though the Deutsche Bank-sponsored products hold futures rather than physical metal in portfolio.

There are, in fact, options on 13 futures-based ETFs extant now, up from the 10 reported in our January look (see "We've Got Options. Sort Of."). When you count the commodity stock ETFs, the option coverage goes up to 17:

FUTURES-BASED

Broad-Based Commodity Indexes

GSG - iShares S&P GSCI Commodity-Indexed Trust

DBC - PowerShares Deutsche Bank Commodity Index Fund

GCC - GreenHaven Continuous Commodity Index Fund

Precious Metals

DGL - PowerShares Deutsche Bank Gold Fund

DBS - PowerShares Deutsche Bank Silver Fund

Energy

USO - United States Oil Fund

USL - United States 12-Month Oil Fund

UNG - United States Natural Gas Fund

UGA - United States Gasoline Fund

DBO - PowerShares Deutsche Bank Oil Fund

DBE - PowerShares Deutsche Bank Energy Fund

Industrial Metals

DBB - PowerShares Deutsche Bank Base Metals Fund

Agriculture

DBA - PowerShares Deutsche Bank Agriculture Fund

EQUITIES-BASED

Precious Metals

GDX - Market Vectors Gold Miners Fund

Energy

KOL - Market Vectors Coal Fund

Basic Materials

SLX - Market Vectors Steel Fund

Agriculture

MOO - Market Vectors Agribusiness Fund

Options provide commodity ETF investors numerous ways to shade or hedge their exposures. For example, the purchase of a put option on a commodity ETF already owned creates an insurance policy against dramatic loss during the life span of the option. The combined ETF/put position behaves as if a call option on the ETF had been purchased: unlimited profit potential on the upside, limited potential for loss on the downside.

Calls provide their buyers, over a specific period of time, the right to buy the underlying fund shares at a predetermined price. The buyer of a put, on the other hand, has the right, but not the obligation to sell fund shares at a specified price. The purchase of a call is a contingent long position in the ETF, while buying a put (if one doesn't already own the underlying ETF shares), is a contingent short.

Sometimes, a "synthetic" ETF position, created by combining a purchased call and a put sold short, can be cheaper than the underlying ETF itself and may be suitable for some investors with relatively short time horizons.

If all this sounds like a muddle to you, examples of option strategies, along with vast amounts of educational materials, can be found at the Option Industry Council's Web site.

Commodity ETF users with already-established option proclivities may want to investigate the natural gas market. Option volume for the United States Natural Gas Fund (AMEX: UNG) jumped 155% on Friday as 10,754 contracts changed hands. It's really no surprise why. Natural gas has been on a tear recently along with the rest of the energy complex. June NYMEX futures are up 54% year-to-date; UNG's gain has been 56%.

UNG closed up more than 1% at $56.40 Friday, tracking futures' higher close. Bulls will find the best odds with the July 53 call priced at $6 or the June 54 call at $4.20.

Probabilities can be bettered with a vertical spread, such as buying the October 50 call against the sale of an October 65 call for a $6.60 debit.