How to Trade Leveraged ETF Options

How to Trade Leveraged ETF Options

Leveraged ETFs are the primary trading vehicle in the equity and ETF markets for numerous professional traders. As we’ve covered previously, leveraged ETFs can provide considerable opportunities to active traders on a daily basis.

Another way to trade vehicles like ProShares Ultra S&P500 (SSO), Direxion Daily Financial Bull 3x Shares (FAS), and ProShares UltraShort Dow30 (DXD) is through options trading. The volume alone of these leveraged ETF options speaks to how popular and increasingly traded these vehicles are.

Just like traders can hold options in other equities, leveraged ETFs offer you the opportunity to apply your personal trading strategy and express your market opinion with long and short calls, puts, and with different options spreads. The inherent leveraged capital that makes trading leveraged ETFs so exciting in the first place is equally applicable in the world of options trading, and offers traders several advantages over trading the underlying vehicle itself.

With the limited risk in comparison to trading other securities, minimal investment required from traders, and potential for exponentially large gains when the markets move substantially, leveraged ETF options are a powerful way to trade the markets.

In the third week of May 2012, ProShares Ultra Gold (UGL) entered a period of extremely oversold territory, and by 5/16 had reached a bottom. Traders who purchased call options in UGL could have taken advantage of this swing and exercised their position by 5/18 to lock-in a solid gain.

As most of you well know, calls and puts are the most straightforward way to trade options, and the same basic methodologies apply when trading leveraged ETF options. Calls allow you the opportunity to purchase the underlying ETF at the predetermined price you’ve designated, regardless of future pricing down the line. Conversely, puts allow traders to sell the same vehicle in the future at the set price they’ve selected. In terms of leveraged ETFs, it’s crucial to choose options that are high-volume and highly liquid in order to properly manage risk and maximize the performance of your trades.

When traded with a quantified strategy, the compounded benefits of options trading with the increased exposure of leveraged ETFs like ProShares UltraPro Dow30 (UDOW), ProShares UltraShort QQQ (QID), and Direxion Daily Small Cap Bull 3x Shares (TNA) can offer traders serious opportunities for short-term gains.

Using options spreads in leveraged ETFs grants traders the ability to hold different expiration dates and strike prices of the option in order to hedge their position, and can be particularly useful when trading leveraged ETFs. Depending on your options trading strategy, trading “in the money” options may be more preferable since they usually track the underlying leveraged ETF more accurately. “Out of the money” options can have their own benefits as well since you have more capital to purchase a larger position, and can produce large gains if the leveraged ETF has substantial movement as it reverts to its mean.

Volatile markets can produce varying results when trading leveraged ETF because of their daily exposure realignment, but that’s why we highly recommend only trading these products on a very short-term basis. Personal exposure needs to be closely monitored when trading these options as it can spiral out of control quickly.

The daily prospects leveraged ETF options can offer to active traders when traded properly is incredibly promising, especially when you consider how many retail traders are currently cutting their teeth on these vehicles without the quantified, historically-backed strategies necessary to facilitate significant gains.

Larry Connors is CEO of Connors Research

Cesar Alvarez is Director of Research of Connors Research

Joshua Glasgall is Editor in Chief of Connors Research