How To Trade ETFs: Why A Bear Call Spread In This Oil ETF May Reap A $120 Profit


The oil and gas sector has pulled back recently after a long period of outperformance. This movement lately offers a good opportunity to explain an options strategy for those who want to learn how to trade ETFs.




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The VanEck Oil Services ETF (OIH) eased 1.5% on Tuesday, and is now trading below the long-term 200-day moving average. Thus, traders thinking the rotation out of oil and gas stocks will continue could look at a bear call spread on this ETF.

I chose this ETF because it typically performs poorly when energy stocks fall. Plus, traders face significantly less earnings risk than trading an individual stock such as Exxon Mobile (XOM).

How To Trade ETFs: Setting Up A Bear Call Spread

That being said, the top two holdings in OIH are Schlumberger (SLB) up to 19.3% and halliburton (HAL) at 13.2%, so these two stocks could have a large impact on the price change in the ETF.

Let’s look at how to trade a bear call spread in OIH.

As a reminder, a bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.

The strategy can turn a profit if the stock trades lower, or even goes sideways. And one can nail a profit even if it trades slightly higher, as long as it stays below the short call at expiry.

On OIH stock, Sept. 16-expiring bear call spread could be set up using the 250 strike as the short monthly call and the 255 strike as the long monthly call.

Maximum Gain vs. loss

On Tuesday, that spread was trading for around $1.20 a share. If executed at that price, the maximum profit on the trade would be $120 per contract with a maximum risk of $380.

The spread will achieve the maximum 31.6% profit if OIH closes below 250 on Sept. 16, in which case the entire spread would expire worthless. This allows the trader to keep the $120 option premium.

The maximum loss will occur if OIH closes above 255 on Sept. 16, which would see the premium seller lose $380 on the trade.

While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy. You always know the worst-case scenario in advance.

Setting A Stop Loss

Investors can set a stop loss if OIH trades above 240, or if the spread value rises from $1.20 to $2.40.

If you think OIH stock will continue moving higher from here, you should not enter this trade.

Even when it comes to how to trade ETFs, please remember that options are risky, and investors can lose 100% of their investment.

Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes in patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at@OptiontradinIQ

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