Exchange-traded funds are baskets of stocks some going up and others going down in price. Generally, this makes these securities less volatile than individual stocks. Lower implied volatility translates into lower option premiums. Of course, there are exceptions but covered call writing with ETFs will usually provide better diversification and less risk at the expense of lower premiums. It would then make sense to set lower option-selling initial time-value return goals with ETFs. As a guideline, I set a goal of 2% 4% for individual stocks and 1% – 2% for exchange-traded funds.
A real-life example with SPDR S&P Homebuilders ETF (NYSE: XHB) : Bullish Technical Chart
Option-chain for the 1-month November 2019 expirations
With XHB trading at $45.18, we will look at the $44.00, $45.00 and $46.00 strikes which generate bid prices of $1.67, $0.98 and $0.49.
Calculations with the Ellman Calculator
All 3 choices fall within the 1% to 2 % initial 1-month time-value return goals. The $46.00 out-of-the-money strikes offers an additional upside potential 1.8% while the in-the-money $44.00 strikes offers an additional 2.6% downside protection of the option profit.
Discussion
ETFs provide more diversification than individual stocks but because of their lower implied volatility, the option premiums are lower than those for individual securities. Therefore, to manage our expectations, we must lower our initial time-value return goals.
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