VTI vs VOO vs VGT: Here’s How They Differ

Posted on November 11, 2021February 14, 2022 by Mike Martin

Last updated on February 14th, 2022 , 07:07 am

Vanguard ETF Comparison

	VTI	VOO	VGT
Issuer:	Vanguard	Vanguard	Vanguard
Index:	CRSP US Total Market Index	S&P 500 Index	MSCI US Investable Market Index IT 25/50
Category:	Large Blend	Large Blend	Technology
Dividend Yield (30 day SEC):	1.15%	1.23%	0.58%
Expense Ratio (fees):	0.03%	0.03%	0.10%
Number of Stocks:	4,025	510	342
10 Year Return:	16.09%	16.17%	22.61%
Growth of 10k Over 10 Years:	$44,462	$44,783	$76,853
Risk (out of 5)	4	4	5

Data from Vanguard

Jack Bogle (founder of Vanguard) once said, “The greatest enemies of the equity investor are Expenses and Emotions.”

Vanguard set out to create funds that 1) were cheap and 2) took the emotion out of the equation.

And boy, were they successful! Vanguard currently offers more than 80 funds in the exchange-traded fund (ETF) space alone. Today, we’re going to compare three of Vanguard’s more popular “emotionless” index-tracking ETFs.

Highlights

Vanguard’s VTI ETF tracks just about all market sectors and capitalizations in the US.
Vanguard’s VOO ETF tracks the S&P 500 Index. This index covers 80% of the market cap in the public space.
Vanguard’s VGT is a more niche fund, condensing its equities across the Information Technology space.
Over the past 10-years, the performance of VGT has far surpassed the performance of VTI and VOO; however, the risks with this ETF are greater.

VTI vs VOO vs VGT: Comparing Benchmarks

The first (and most important) difference between our three ETFs lay in the different indexes they represent and attempt (quite successfully) to track.

Most everyone has heard of the S&P 500 Index, which VOO tracks; but what is VTI’s underlying index, the CRSP US Total Market Index, all about?

Additionally, what about VGT’s MSCI US IMI Information Technology 25/50 Index? What the heck does that mean?

Let’s figure it out!

VTI: CRSP US Total Market Index

As stated in the fund’s prospectus, the ambitious aim of the Vanguard Total Stock Market ETF (VTI) is to track “the performance of a benchmark index that measures the investment return of the overall stock market.”.

So how, exactly, does Vanguard go about this? By composing an ETF that seeks to track the performance of the CRSP US Total Market Index.

CRSP is the acronym for The Center for Research in Security Prices. The CRSP index (under the ticker CRSPTMT) is the brainchild of the CRSP organization, which is affiliated with the University of Chicago Booth School of business. Here’s how they define their index:

Vanguard does a fine job of tracking this immense index, which is why Morningstar gave the fund 4 stars.

Vanguard’s VTI contains an impressive portfolio of over 4,000 stocks, mimicking that of the CRSP Index. What differentiates this index from the other ones on our list is its breadth; VTI doesn’t limit its exposure to only large caps (like VOO) or technology stocks (like VGT) but includes equities of all capitalizations classes (small-cap, mid-cap, and large-cap).

Vanguard’s VTI fund focuses on domestic stocks. If an investor wanted to add international stocks to their portfolio, they could buy the Vanguard Total International Stock ETF (VXUS) and be completely diversified across all equities in existence.

VOO: S&P 500 Index Explained

Vanguard’s VOO ETF seeks to track the performance of the S&P 500 Index. This index is the most followed in the entire world. It has been the benchmark for innumerable funds since its inception in 1926.

The aim of the S&P 500 Index (maintained by S&P Dow Jones Indices) is to track the performance of the largest 500 publicly listed companies in the United States.

Out of the over 4k publicly listed companies in the US, 500 of these contain 80% of the entire market capitalization. That’s impressive, and probably the reason Warren Buffet so strongly advocates for long-term investors to invest in cheap, S&P 500 Index funds like VOO.

VGT: MSCI US IMI IT 25/50 Index Explained

Vanguard’s VGT fund is information technology-obsessed. As stated from the fund’s prospectus, VGT “seeks to track the performance of a benchmark index that measures the investment return of stocks in the information technology sector.”

So what benchmark does it use? The MSCI US IMI Information Technology 25/50 Index (USD). That’s a mouthful! So what does this mean? Let’s go to the MSCI website to find out.

When you think about information technology, think Microsoft, Apple, NVIDIA, etc. When compared to VTI and VOO, VGT is much narrower in scope, containing only 342 stocks in its fund. However, this narrow breadth does not mean narrower profits; check out the below graph, comparing VGT (blue line) to the other two ETFs on our list over the past five years (which run together), ending in November of 2021.

VTI vs VOO vs VGT

Chart from Google Finance

VGT is a great alternative to Invesco’s QQQ ETF, which charges a management of 0.20%, twice that of VGT. Additionally, VGT has been outperforming QQQ in recent years.

Let’s take a look at our funds’ different expense ratios next!

VTI vs VOO vs VGT: Comparing Fees

All of the expense rations for our three ETFs are incredibly low.

Bearing in mind that the average ETF fee is about 0.40%, they are all winners. An investor may be remiss to cut VGT out of their portfolio because of its slightly higher expense ratio; when you look at the performance of this ETF (which we touched on above, but will go into detail later), it is my opinion that VGTs meager 0.10% management fee is well earned.

VTI vs VOO v VGT: Sector Diversification

We touch briefly upon the different sectors our ETFs are invested in earlier. Let’s really drive that home now.

The below table shows the top sectors that VTI, VOO, and VGI invest in, respectively.

VTI vs VOO vs VGT: Comparing Top Sectors

Sector	VTI	VOO	VGT
Technology	24.54%	24.65%	89.77%
Financial Services	13.88%	14.09%	8.12%
Health care	13.62%	13.62%	0.00%
Consumer Cyclical	11.81%	12.11%	0.00%
Communication Services	10.51%	11.29%	0.55%
Industrials	9.01%	8.39%	1.57%
Consumer Defensive	5.65%	6.21%	0.00%

Data from Vanguard

VTI vs VOO v VGT: Largest Stock Holdings

So we know the sectors these different ETFs invest in, but what specific stocks do they invest in within these sectors?

The below table lists the largest 7 holdings of each ETF on our list.

VTI vs VOO vs VGT: Top Stock Holdings

Rank	VTI	VOO	VGT
1.	Apple Inc.	Apple Inc.	Apple Inc.
2.	Microsoft Corp.	Microsoft Corp.	Microsoft Corp.
3.	Alphabet Inc.	Alphabet Inc.	NVIDIA Corp.
4.	Amazon.com Inc.	Amazon.com Inc.	Visa Inc.
5.	Facebook Inc.	Facebook Inc.	Mastercard Inc.
6.	Tesla Inc.	Tesla Inc.	PayPal Holdings Inc.
7.	NVIDIA Corp.	NVIDIA Corp.	Adobe Inc.

Data from Vanguard

Notice how VTI and VOO have the same exact top 7 holdings. These ETFs are very similar in nature. Remember, the only difference between them is VTO includes small-cap stocks while VOO focuses only on large caps.

VTI vs VOO v VGT: Price Performance

Last up, let’s take a look at the historical price performances of our three ETFs.

Average Annual Performance- Quarter End

Duration	VTI	VOO	VGT
1-year	32.04%	29.96%	29.81%
3-year	16.04%	15.95%	26.96%
5-year	16.88%	16.86%	28.63%
10-year	16.61%	16.59%	23.07%

Data from Vanguard

Final Word

It’s impossible to pick a winner when comparing our three ETFs. Why? All of these funds have different risk profiles. In volatile times, VGT tends to decline faster than VTI and VOO, which perform very similarly. However, just the opposite is true in bullish markets.

In terms of sheer diversification, VTI is the clear winner.

Additional Resources

VTI ETF Report: Ratings, Analysis, Quotes, Holdings etf.com

A Look at Vanguard’s S&P 500 ETF – Investopedia

ProShares BITO ETF Explained

Posted on November 11, 2021February 11, 2022 by Mike Martin

Last updated on February 11th, 2022 , 10:54 am

The long-awaited first futures-based bitcoin ETF is about to start trading.

ProShares will be the first to market with their BITO ETF.

Just a few days before this announcement, projectfinance coincidentally wrote an article on the risks of futures-based ETFs. Be sure to check that out for a more in-depth understanding of how these types of funds work.

Though many investors will surely buy ProShares BITO ETF on the day it begins trading, the savvy investor will do a little research before jumping the gun.

In this article, projectfinance aims to aid in this research by taking a step back, and examining what, exactly, is inside the ProShares BITO ETF.

Additionally, we will take a look at a few of the pros and cons that come from ProShares’ “futures-based” methodology to track bitcoin.

Highlights

A futures-based ETF poses significantly more risks when compared to traditional equity ETFs
Contango, futures markets halts and incredibly high expense ratios will eat away at the value of bitcoin ETFs, such as BITO.
A bitcoin ETF will introduce some benefits, such as ease of access, broker SIPC protection and potential backwardation
Net-net, investors will probably be better off investing directly in bitcoin rather than the BITO ETF

Introducing BITO: ProShares Bitcoin ETF

Most retail investors are familiar with equity-based ETFs, such as State Street’s S&P 500 ETF, SPY. This ETF invests directly in the stock of the companies which comprise America’s largest 500 companies. The correlation of the SPY ETF is tightly aligned to the S&P 500 index.

The value of ProShares BITO ETF, whoever, is not derived from stocks, nor is it derived from actual bitcoin; it is derived from the value of futures contracts that track bitcoin.

The below is taken from ProShares BITO “Prospectus”.

ProShares’ approach here will almost inevitably result in inefficiency. However, a futures-based ETF on bitcoin will also offer investors a few advantages when compared to investing in the actual coin.

Spoiler Alert: In my humble opinion, when compared to owning bitcoin outright, the risks of a futures-based bitcoin ETF far outweigh the potential rewards.

Let’s start off by exploring why a futures-based bitcoin ETF may be a disaster in waiting.

Cons of a Futures-Based Bitcoin ETF (BITO)

From a tracking risk perspective, a bitcoin ETF formed from futures products certainly poses numerous risks. Let’s look at a few of these risks now.

1. Contango in ProShares BITO

Contango is first here for a reason. In almost all futures-based ETFs (like BITO), the passing of time eats away at the value of the product. Why?

We mentioned earlier that BITO will not invest in actual cryptocurrency, but futures contracts on the Chicago Mercantile Exchange (CME) that track bitcoin.

But futures contracts expire. Therefore, to remain invested in bitcoin, ProShares must “roll” their bitcoin futures from one month to the next.

At the time of this roll, we will receive usually fewer proceeds for the closer, or “front-month” contract than we pay for next month’s contract. This doesn’t happen all the time (more on backwardation later), but it happens most of the time. Some months, the discrepancy in pricing can be quite material. You can see this discrepancy in the image below.

The result? Every month, the ETF will shed a little more value. Perhaps barely perceptible at first, added up over 12 months, you will for sure see this decay in action. And after 12 years? You’ll probably wish you had invested directly in the coin.

Bitcoin Futures Quotes

2. BITO ETF and Futures Market Halts

Products that trade on futures markets in the US are at risk of being halted. This happens when a product either increases or decreases in value too much over the course of a trading day.

In May of 2021, the price of bitcoin dropped so much, the Chicago Mercantile Exchange halted trading on bitcoin futures contracts.

At this time, Canada had already approved 2 bitcoin ETFs (issued by Horizon ETFs). Because of this halt, the issuer was at risk of not being able to honor the days buy and sell orders.

Bitcoin ultimately rallied and began trading again shortly after the halt, so we’ll never know how bad this situation could have gotten.

This could very well happen in the BITO ETF. Given bitcoins volatility, it seems more a question of when, not if.

3. BITO’s Insanely High Expense Ratio

Let’s talk for a moment about what few are talking about: the painfully high expense ratio of 0.95% that ProShares BITO ETF is charging.

Source: ProShares.com

I couldn’t believe this expense ratio when I saw it. Perhaps I’m spoiled (most of my ETFs at Vanguard charge less than 0.10%), but, in 2021, I would never pay almost 1% for a company to manage my ETF. This is especially true when considering the fact BITO is almost sure to underperform the underlying.

If bitcoin performs half as well as many forecasters believe it will, that almost 1% over the course of thirty years could very well cost you a shiny new car.

When this expense ratio is coupled with the decaying risk of contango, investors should for sure second guess investing in the BITO ETF.

Pros of a Futures-Based Bitcoin ETF (BITO)

There are indeed a few advantages to a bitcoin ETF. For those that like to make lemonade out of lemons, read on.

1. BITO ETF Offers Better Correlation than Trusts

Up until the release of a bitcoin futures ETF, the only exposure retail investors had to cryptocurrency was either through futures contracts or trusts. Futures entail too much risk for the average investor, and the correlation between cryptocurrency trusts and their representative underlying coin has been undulating wildly.

Take a look at the below image from TradingView comparing the price performance of Grayscale’s GBTC Trust to Bitcoin.

When compared to cryprocurrency trusts (such as GBTC and ETHE), a bitcoin ETF should provide a better correlation with the coin itself. The futures ETF approach is formulaic and contingent less upon wavering supply/demand, which caused the above miscorrelation.

2. BITO ETF May Benefit from “Backwardation”

We talked earlier about the risks of BITO and “contango”. A possible benefit of BITO would come with an opposite market dynamic: backwardation. This market anomaly occurs when longer-dated bitcoin futures trade below front-month futures contracts. Just remember, this is a RARE event.

3. BITO ETF Eliminates General Hassle of Owning Bitcoin

Deciding to purchase bitcoin outright can be a lengthy, time-consuming process. If you want to own an actual bitcoin, you must:

1. Choose a crypto exchange

2. Create and set up an account verification method (which may be difficult for older, less technologically savvy investors)

3. Link the account to your bank and deposit funds

4. Trade the actual currency

5. Choose a storage method for the currency (the most time-consuming of all the steps)

6. Track buys/sells for year-end tax reporting

Now compare the above steps to simply queuing a buy order in your trading software for “BITO” and getting a 1099-B in the mail.

4. Buying BITO through a SIPC Recognized Broker Offers Security

Most futures-based ETFs are purchased through brokers. Many investors using brokerage accounts are protected under the Securities Investor Protection Corporation (SIPC). The SIPC provides financial insurance should your broker fail. Though this insurance does not protect the securities in your account, it will help to cushion the blow should your broker have a liquidity crisis.

Why is this important? You may remember a now-defunct crypto exchange out of Japan called Mt. Gox. At its zenith, the exchange handled more than 70% of crypto transactions worldwide. In 2011, hackers broke through the exchange’s security and began siphoning out bitcoins from customer accounts. We’re not talking one or two; the hack resulted in a loss of 850k bitcoins, which represented more than 5% of bitcoin in circulation at the time.

SIPC insurance provides some financial protection to you should your broker fail. The below is taken from the SIPC website:

Mt. Gox did not have SIPC insurance, but chances are, if you purchase BITO through a broker like Tastyworks or Ameritrade, your account is protected (up to the above listed dollar amount).

NOTE: Again, this insurance does not protect the value of BITO; it simply protects against your broker failing.

Of course, there still is a risk here. When Mt. Gox was hacked, bitcoin tanked by 20%. Can you imagine what would happen to the price of bitcoin today if Coinbase was hacked? A futures-based ETF would plummet right along with the underlying product.

Final Word

For investors who don’t want to spend the time or effort investing in bitcoin directly, futures-based bitcoin ETFs such as ProShares’ BITO is probably the next best option.

That being said, if in 20 years bitcoin has skyrocketed from its current level, you will likely regret not taking the time to invest in bitcoin the more traditional way. Additionally, you could also invest in a company that invests in bitcoin, such as Microstrategy.

With BITO, you will pay a premium that is not, in my opinion, worth it.

Bullish vs Bearish and Long vs Short Explained

Posted on November 10, 2021February 14, 2022 by Mike Martin

Last updated on February 14th, 2022 , 10:09 am

There are a lot of new terms that beginner investors must learn. Some of them can be incredibly complicated; others are rather straightforward. This article is going to cover a few of the more straightforward trading terms.

Understanding the difference between bullish vs bearish as well as long vs short is vital. These terms are the building blocks upon which other investing narratives build. Let’s get right into it!

TAKEAWAYS

“Bullish” investors believe prices will rise
“Bearish” investors believe prices will fall
A “Long” position indicates an investor owns a security
A “Short” position indicates borrowed securities. Generally speaking, an investor “short” a security speculates the price will fall.

Bullish vs Bearish

What strange words the investing world uses to describe market direction! But at least they’re named after animals; at least they’re relatively fun.

Before we dive into the meanings of these two words, let’s do a brief history of their origin. Additionally, knowing how these terms came to be may help you remember them.

Origins of Bullish and Bearish

Ever watch a tourist get gored during the running of the bulls at the San Fermin Festival in Pamplona, Spain? If so, remembering what a “bull market” is will be easy for you.

When a bull attacks, the animal thrusts its horns into the air (along with any unsuspecting tourists from Ohio). In other words, the bull’s head goes “up”.

Since there are no “running of the bears” (yet), understanding what “bearish” means may not be as intuitive.

The origin of the term bearish is not as cut and dry. In truth, nobody can say for certain where it comes from. A deep dive revealed the history of the term bearish involved something called “bearskin jobbers”, trappers and medieval brokers. Let’s skip that definition and go on to the easier one, shall we?

A bear attacks by raising its giant paw and swatting prey down. Hopefully, you haven’t learned this empirically. This is how we will remember what a “bearish market” is: downward.

Bullish

The term “Bullish” is a metaphor for an upward trending market. If we are in a bullish market, prices keep going up, just like the body of that tourist. Bullish investors believe the price of a security or securities will rise in value.

Bearish

The term “bearish” is the exact opposite of bullish. A bullish market is a downward trending market. The stock market is considered bearish if the overall prices of stocks are falling.

When the pandemic hit, the market was bearish. When the economy rebounded, it was bullish. Therefore, bear markets are bad for an economy; bull markets are good.

Bullish and Bearish Sentiment

If you spend any time watching CNBC, you’ll hear the word bullish and bearish peppered into every other sentence. We learned before that a bullish market goes up and a bearish market goes down. But what about the future of a market?

If you believe a market is going to go up in the future, you are bullish. If you believe a market is going to go down in the future, you are bearish.

Nobody knows for certain which direction a market (any market at all) will go in the future, but those talking heads on TV sure do like to give their opinion on the matter. This bullish and bearish guessing is called “speculation”.

Market Neutral

Additionally, you can be neither bullish nor bearish. What is the word for this term? Not some sort of crossbred nightmare animal as I wish it were (Beull? Isn’t that a motorcycle?), but simply “neutral”. If you’re “market neutral” you don’t think a market is going to go anywhere at all.

Perhaps the best way to take advantage of a neutral market is with call-and-put options.

So now you can impress (or bore) your friends at the pub next Saturday with some new terms. But what if they fire back some other terms that you don’t understand? What if they say, “So you’re bullish; what exactly are you long?”

So what the heck does “long” mean? I’m 6’2, so I guess I’m long.

Long vs Short

Things get a little more complicated when we are talking about long and short. Let’s take a look at the (potential) origin of these terms so we can understand them better.

Origins of Long and Short

Trying to figure out the origins of long vs short becomes a bit more ambiguous. One theory is that the terms came from a medieval method of record-keeping called “tally sticks”, as seen below.

In old England, accountants of the crown made notches on these sticks to record proof of payment between parties. The stick was then split lengthways into two pieces; a long piece and a short piece. The long piece was then given to the “payer” and the short piece was given to the “seller”. At a later date, the parties would place the pieces together to make sure they fit in a process called “tallying”. This fitting together of the pieces confirmed that a previous transaction had indeed taken place.

I believe the UK Government has since updated its record-keeping methods.

Since the party who received that larger stick paid, they were considered “long’. The party that had the shorter piece of the stick “owed”, and was thus short. This may make the process of separating the two terms easier (or perhaps more difficult) for you.

Long

If you have a “long” position in an asset/security, you own that security. For the most part, if you are long something, you want it to go up in value. However, there are many exceptions to this rule (more on this in a bit).

You can use this term to describe anything you own. On a recent trip home, I remembered I was “long” several thousand baseball cards. Unfortunately, they have not gone up in value.

In the stock market, you can either be long or short stock. If you are long shares of Apple (AAPL), for example, you actually own part of that company. You can even vote on important decisions the company makes in something called a “proxy”. If you are long AAPL stock, you obviously want it to go up in value.

The vast majority of investors are long stocks. An investor who went long $100 worth of stocks within the S&P 500 in the year 1900 would have over $8.5 million today. That’s not a bad return. A lot of that return comes in the form of dividends. If you are long something, you have rights. Short sellers? Not so much.

Short

Selling short is the exact opposite of going long. An investor who shorts a stock speculates that that stock will decline in value.

How do you go about selling something you don’t own? The markets allow participants to borrow shares from a broker while simultaneously selling these shares. An investor who does this will profit when the stock goes down in value.

If the market does indeed decline in value, that investor can buy the shares back for a profit. When an investor buys back their short shares, they simultaneously return the borrowed shares to their broker, and they are “flat”, or have no positions.

Short Selling Example

If this concept sounds confusing (as it did to me when I first learned it) here’s a tangible analogy.

Let’s say your best friend just paid $500 for a new Xbox. Before he opens it, you ask to borrow it. He agrees. You then immediately sell it to someone else for $550.

Your (ex) best friend is upset and demands you replace it. You find a new Xbox on eBay for $500. You buy this Xbox and give it to him, pocketing the $50 in profit.

In a nutshell, that’s short selling. The only difference is that instead of an Xbox, you’re borrowing stock from your broker to sell to someone else – and they know your intentions.

There has been a lot of talk about banning short selling. This would be a mistake (and very unlikely). The ability to sell short is a cornerstone of capitalism. If short sellers didn’t exist, the stock market would rise inexorably before crashing epically.

Just think about what would happen during a debate if you were only allowed to agree.

GameStop and Short-Selling

Short selling has significant risks. You may recall the GameStop (GME) battle of 2021 between Reddit and Wall Street. If you buy a stock at $20 and sell it for $300, you just made $280 a share. Not bad!

However, if you sell shares of GME (as many hedge funds were doing) at $20, and GME rises to $300, you just lost $280/share. The losses precipitate, and what follows is a herd of short-sellers rushing to cover their positions in what is called a “short squeeze”.

When selling short stocks, you can lose a lot more than you invest. When you go long a stock, you can only ever lose 100% percent of your initial investment (assuming the stock goes to zero).

Something called “gamma squeeze” happened on this stock as well. Learn more about this options trading term here, “Gamma Squeeze Explained“.

Short Selling = Infinite Risk

When you short a stock, you have in theory infinite risk, since there is no telling how high that stock may go. This can lead to what is called a “margin call”. This happens when your broker says, “Alright, you lost a lot of money on this short stock; what if the stock continues to go up and you don’t have the funds to cover the losses? Then we’re at risk. We require more money for you to hold the position, or we’re going to liquidate your account.”

In short (no pun intended), just know that if you short a stock, you want it to go down in value. The mechanics can get quite complicated.

So by now you probably think that “long” is synonymous with “bullish and “short” is synonymous with “bearish”: Why aren’t they just the same word?

Sometimes, a long position can actually be bearish, and a short position bullish. Let’s take a look at a few of these exceptions.

Exceptions to the Rule

Chances are that if you’ve heard of GameStop, you’ve heard of options trading as well. Options trading allows investors great leverage in the marketplace. Instead of trading stock, an options trader is buying the right to either buy or sell stock.

There are two types of options contracts; calls and puts:

A “put option contract” is a financial derivative that allows an investor to profit when a stock goes down in value. Put contracts give an investor the right to sell shares of stock at a specific price (strike price) by a certain date (expiration date). Unlike stock, options are contracts, and thus expire over time.

A “call option contract” is a financial derivative that allows an investor to profit when a stock goes up in value. Unlike put contracts, call contracts give an investor the right to purchase shares of stock at a specific price (strike price) by a certain date (expiration date).

If you are “long” a “put contract”, you are betting that the market will go down in value. Therefore, not all long positions are bullish.

Huge profits are made and lost in options trading. If you’d like an introduction to options trading, feel free to check out our free YouTube guide below. Over 10 million YouTubers have already done so!

Option Trading for Beginners

Final Word

The majority of the time, you can equate long with being bullish, just as you can equate short with being bearish. If you’re only talking about individual stocks, you will generally be safe. Some exchange-traded funds (ETFs), however, actually are designed to make money when the market goes down.

For long-term investors, bullish and long is generally the only way to go.

Thanks for reading, and happy trading!

Additional Resources

What is a gamma squeeze – IG

Long and Short Positions – Corporate Finance Institute

What Does “Bullish” Mean in Stock Trading? | The Motley Fool

Shorting Put Options for Income Explained

Posted on November 9, 2021February 11, 2022 by Mike Martin

Last updated on February 11th, 2022 , 11:35 am

The above graph represents the profit/loss of a short put option at expiration, where X represents the strike price of the put sold.

Short Put Option Definition

Selling (writing) put options is a neutral to bullish options trading strategy with potentially great risk. Since short-put sellers are the counterparty to long-put buyers, traders utilizing this strategy incur the obligation to purchase the underlying security at the strike price specified should the long party exercise their long put option.

Short Put Option Inputs

● Short Put Option at Strike Price X

Short Put Option Profile

Maximum Profit: Put Sale Price (Credit Received) x 100

Maximum Loss: (Put Strike Price – Credit Received) x 100

Breakeven Price: Put Strike – Credit received

Probability of Profit: Between 50-99% Depending on Strike of Put Sold

Assignment Risk: Increases with Falling Extrinsic Value

In an environment where interest rates are hovering near 0%, investors are seeking alternative ways to generate income.

Many investors are turning to selling put options for income. This market-neutral/bullish options strategy is more popular than ever amongst income-thirsty investors.

Why? The majority of the time, selling put options is a great way to generate steady income. However, this relative stability of income comes not without great risks.

Highlights

When you sell a put option “naked”, the most you will ever make is the premium received; maximum loss can be enormous, occurring only rarely when the underlying falls to $0 in value
Options premiums increase with time and implied volatility
A short put option that is out-of-the-money at expiration will expire worthless and the full premium will be collected
Traders have three choices when their put option is near or at-the-money as expiration nears; close the put in the market, be assigned and purchase the stock, or “roll” the trade via a calendar or diagonal spread

In order to understand the short put options trading strategy, we must first understand the mechanics of long puts.

Long Put Option Explained

Traders who buy put options are typically extremely bearish on an underlying stock/security. Let’s take a look at the textbook definition of a long put, then jump right into an example.

Long Put Option Definition: A long put option is a derivative that gives the owner the right, but not the obligation, to sell a certain amount of a security (stock) at a specified price (strike price) by a specific date (expiration date).

Long Put Option Example

Let’s assume we are extremely bearish on AAPL with the stock trading at $151. We are quite confident the price will fall dramatically in the time leading up to, and following, the company reporting earnings in the weeks ahead.

After scanning the options chain for puts, we decide to purchase a 145 s put on AAPL expiring in 39 days. Below, you will find the details of our trade.

AAPL Long Put Contract

Initial AAPL Stock Price: $151

Put Strike Price: 145

Expiration: 37 Days Away

Put Purchase Price: $2

Put Breakeven Stock Price: 145 Strike – $2 Debit = $143

Maximum Profit Potential: $143 ($14,300)

Maximum Potential Loss: $2 ($200)

In the above example, we purchased an out-of-the-money put at the strike price of 145 for a debit of $2. Whenever you purchase an option (or anything!) the most you will ever lose is the purchase price paid. Therefore, when we buy this option, we can only ever lose $2 (or $200 taking into account the multiplier effect of 100).

Under what circumstance do we lose the entire premium paid? If the stock price closes above our strike price at expiration. Put options give the holder the right (but not obligation) to sell stock at the strike price. Why on earth would anyone want to sell stock at the strike price if the market stock price is more favorable? They wouldn’t.

How much can we make on this trade? Our best-case scenario will happen if AAPL is trading at zero by expiration (unlikely!). We paid $2 for a put option at the 145 strike price. To determine our maximum profit, just subtract the debit paid from the strike price (145-2) and that will give us a maximum potential profit of $143 ($14,300). This will occur with AAPL trading at zero on expiration in 39 days; again, unlikely.

Short Put Option Introduction

Options are incredibly versatile investment vehicles. You can combine calls and puts in innumerable ways. In addition to buying options, you can also sell options.

Many professional traders exclusively sell options. Selling options naked, however, introduces traders to potentially devastating risks. Let’s return to our above AAPL trade, but this time let’s sell the put option instead of buying it. Here are our trade details:

AAPL Short Put Contract

Initial AAPL Stock Price: $151

Put Strike Price: 145

Expiration: 37 Days Away

Put Sale Price: $2

Put Breakeven Stock Price: 145 Strike – $2 Premium= $143

Maximum Profit Potential: $2 ($200)

Maximum Potential Loss: $143 ($14,300)

We are going to focus on two components in the above table: maximum profit and maximum loss.

Maximum Profit in Short Puts

In our previous long put example, our maximum profit was $143 ($14,300). In the short put example above, our profit is only $2 ($200). Why is this? When you sell an option, the most you can ever make is the premium received.

Long put options are profitable only in bearish markets. Short put options, however, are profitable in neutral, bullish and even minorly bearish markets. In theory, this strategy should be profitable the majority of the time.

When you sell a put option, probability is on your side. Of course, you give something up for your high odds of success. This comes in the form of risk.

Maximum Loss in Short Puts

When you sell a put optoin, your maximum loss occurs when the stock is trading at zero on expiration. For our trade, we would incur a loss of $143 ($14,300) if AAPL were to fall to zero by expiration. That’s a lot of money!

We are risking over 14k to make a lousy $200. Is that a trade you’d like to make?

Probably not. So why do so many investors sell put options for income?

Because chances are, the stock price will not be zero when our option expires. Chances are, AAPL will be trading above $145, resulting in a maximum profit to us.

So what, exactly, are the odds our trade has of achieving maximum profit? The Greek “delta” tells us. Let’s take a look at how delta interacts with different strike prices next.

Short Put Options: Choosing a Strike Price

Traders who sell put options for income generally sell strike prices that are considerably out-of-the-money. Why? The further out-of-the-money a put option is, the greater the odds that option will have of expiring worthless.

But can we determine what these odds are by a method other than guessing? Yes!

Take a look at the below put options chain for Invesco QQQ Trust (QQQ) on the tastyworks trading platform.

QQQ Put Options and Delta

We are interested in the column titled “Delta” in green. Delta is one of the option Greeks. This Greek can be useful in many ways, including telling us the odds that an option has of expiring in the money.

Delta and In-The-Money Odds

QQQ is currently trading at $399/share. The put options in the above table expire in 9 days.

Take a look at the 399 put. Its delta is -0.50. This tells us the 399 at-the-money option has a 50% chance of expiring in-the-money. This should make sense; since the stock is trading at this same price, there should be a 50/50 chance that AAPL will either be above or below this level at expiration.

Let’s look at the 390 put now. In order for this option to be in-the-money, the stock needs to fall by $9 by expiration, which is 9 days away.

What are the odds this happens?

Just look at the delta, which is -0.23 for the 390 put. This option, therefore, has a 23% chance of expiring in-the-money on expiration. In other words, if you sell this put option, you have a 77% chance (100-23 delta) of the option expiring worthless and achieving maximum profit.

77% chance of success sounds pretty good. However, take note of how the premium dwindles the further out-of-the-money you go. If you recall the massive maximum loss potential on short puts, this low premium does not make for a very nice risk/reward profile.

Short Put Options and Time Value

The time-to-expiration will affect how much premium you can collect from selling a put option. The greater the time to expiration, the greater premium you will receive. Take a look at the below two options chains on the QQQ’s from the tastyworks trading platform.

QQQ Put Options and Days to Expiration

The options in the green square on top expire in 2 days; the options in the lower green square expire in 11 days.

Compare the pricing on the 396 puts expiring in 2 days to the 396 puts expiring in 11 days. The options with 2 days left are trading at $1,14, while the options with 11 days left are trading at $3.80.

Additionally, you can see the delta (or the odds of expiring in-the-money) increases for options with more days to expiration.

Why is this? The underlying has more time to approach the strike price level. A lot of options trading can be understood without using math at all; instead of understanding rules, just think intuitively about a scenario, and it should make sense.

Short Put Options and Market Volatility

High implied volatility is synonymous with high options premiums.

Broad market volatility can be gauged by looking at the VIX index. The VIX index measures the market’s expectations for volatility over the proceeding 30 days based on near-term S&P 500 index options. The higher the level of the VIX, the higher the premiums for options will be.

Traders looking to sell put options for income could receive a greater premium if they sell during times of elevated volatility. However, this comes with greater risks too – in volatile times, the underlying has a greater chance of plummeting and breaching the strike price of put options sold.

Take a look at the below 5-year chart, which compares SPY (an S&P 500 tracking ETF) to the VIX. When the blue line is at its zenith, options premiums are very elevated. Notice how this coincides with large downturns in the SPX.

Chart from Google Finance

Short Put Options and Stock Volatility

The levels of implied volatility on individual stocks can vary widely.

Two stock trading at the same exact price can yield vastly different option premiums (and risks) for similar strike prices. Check out the below options chains from tastyworks, comparing two stocks currently trading at the same exact price.

LMT Put Options

Bill Put Options

The underlying stock prices for the above two options chains (BILL and LMT) are both trading at $342/share.

Why, then, are the premiums so vastly different?

Comparing Implied Volatility in Options

The 340 put option for BILL is trading around $12, while the 340 put option for LMT is trading at $4, about a third of the price. The underlying stock, however, is trading at the same exact price for both. Additionally, the time to expiration (10 days) is also the same. Why such a huge difference in premium?

We’ll find our answer in the upper right-hand corner of the options chains, where I have circled the “Implied Volatility” (IV) in green.

IV measures the expected volatility of an underlying security over the life of an option. For the November 19 options above, the IV for BILL is 64.6% while the IV for LMT is only 7.59%.

The greater the IV, the higher the premiums (and risks!) options will have. History tells us that the stock of BILL undulates more wildly than that of LMT, therefore the pricing of BILL’s options must be elevated to reflect the stock’s future potential moves.

Selling Put Options and The Greeks

We touched upon the Greek “delta” earlier. However, if you want to be a pro options trader, having all of the Greeks in your toolbox is a must. Below, we have provided a cheat sheet that shows the relationship between short put options and the Greeks.

Short Puts & The Greeks

If you’d like to learn more about the Greeks, read our article, “Option Greeks Explained: Delta, Gamma, Theta & Vega.”

Historical Performance of Selling Put Options

The best resource we have for the long-run profitability of selling put options comes from The Cboe S&P 500 PutWrite Index, PUT.

The PUT index tracks the performance of at-the-money puts, not out-of-the-money puts, which are the favorite amongst traders looking to generate income.

Short at-the-money puts have greater premiums than out-of-the-money puts. They also have a lower chance of expiring worthless.

With that being said, the index does give us a ballpark idea of the long-term performance of selling put options against an index (SPX).

The below chart compares the historical dollar comparison performance of PUT (green) to SPX (black).

Source: CBOE Website

Since its inception in 2007, the PUT index has vastly underperformed the SPX index.

Closing Short Put Options

If all goes as planned, your short put option will expire worthless, and you’ll collect the full premium from the trade.

But sometimes, the market moves against us. If you are short a put option and the underlying is close to or has already breached your strike price at or near expiration, you have one of three options:

1.) Let the option be assigned and purchase the stock.

Some traders that sell put options for income do so with the intent to purchase the stock should it breach the level of the put sold. Purchasing stock, however, can be quite costly, so it is advised that traders have the capital required to hold the underlying shares in these scenarios, or else your broker will liquidate the position.

2.) Close the put in the open market.

If you want to throw in the towel on your trade, the best option is to simply buy back your short put in the market.

3.) Roll your put option.

If you want to remain in the position, you can always “roll” your short put from one expiration cycle to another. This can be accomplished in a single trade. Your options are a “calendar spread” or a “diagonal spread”.

Calendar Spread: In a calendar spread, you will simply roll the same strike price from one expiration to another
Diagonal Spread: Sometimes, traders want to sell a put option that is further out-of-the-money when their short is breached. A diagonal spread can accomplish this. This strategy consists of buying and selling options of the same type, but opposing strikes and expirations.

Final Word

Selling put options naked is a risky business. The odds are in your favor for this income generation strategy, but when the market moves against you, watch out.

In my days as an options broker, I have seen years of profits from selling puts wiped out in a single day. It is because of this many traders refer to selling options naked as “picking up pennies in front of a steam roller”.

Be careful out there, traders!

Next Lesson

Additional Resources

How to Sell Put Options to Benefit in Any Market – Investopedia

Selling Put Options: Tutorial + Examples – Lyn Alden

Short Put Option Strategy: tastyworks

Payment for Order Flow Explained Simply (w/ Visuals)

Posted on November 5, 2021April 27, 2022 by Mike Martin

Last updated on April 27th, 2022 , 04:59 am

For sixteen years, Gary Gensler, (the Chairman of the SEC) had his heart set on improving the profits at Goldman Sachs. Today, it is set on the advocation of retail traders. He wants to do away with payment for order flow.

Payment for order flow (PFOF). Doesn’t it sound sinister? Like some kind of Faustian deal? The father of it may even be thought of like a modern-day Mephistopheles: none other than Bernie Madoff invented the system, whereby brokers receive compensation for routing their orders to market makers.

So how, exactly, does this system work?

Highlights

In payment for order flow (PFOF), market makers pay brokers for filling customer orders
In these flash-auctions, the best bid/offer wins; payment is sent from the market maker to the broker for filling the order, and the customer is filled
Outwardly, wholesale market makers welcome an end to PFOF as this means they’ll simply fill the same orders without having to pay
More transparency is needed in the system to assure investors they are indeed receiving the best fills possible

Payment for Order Flow Example

Let’s say your friend Fred wants to sell his apple. He hires you (the broker) to sell this apple for him. You then take the apple to market.

For a long time, there were only a few vendors in town. We will say three (market makers on public exchanges like the CBOE, NYSE, NASDAQ).

Now if you are selling an apple for a client, wouldn’t it be better if there was more competition? We want them to fight for the right to purchase our apple, thus making the spread tighter.

A few outsiders (wholesale market makers like Citadel and Virtu) got wind of the wide spreads in the apple market. One day, they are standing next to the major vendors, giving you their own markets.

Our apple auction begins. The newbies are aggressive and offer you the best fill, better than the old players. In fact, two of these best markets presented to you by the newcomers offer you the same price.

So who do you sell the apple to?

One vendor (market maker) says they’ll personally pay you a penny if you send him the order. This is money you can put in your pocket. This is NOT money for Fred.

You sell the apple to this party and then walk home, rolling that penny over in your pocket the entire time.

“Here’s your money.” you say to Fred, “Also, I got paid a penny, but I sold the apple at the best possible price.”

“Cool.” replies Fred.

“I am going to invest this penny in new pair of sneakers so I can get to the market faster.”

“I don’t care.” replies Fred.

Payment for Order Flow: A Benefit to Retail Traders?

Of course, in this situation, our apple is stock or options (most likely to be options) and the apple vendors are market makers. You are the broker here.

So what about that money you collected from the market maker? Instead of sneakers, you will use the funds to invest in technology and pay for the cost of your operations. After all, if you run an apple to the market for someone, shouldn’t you get paid? Capitalism isn’t charity.

In a nutshell, this is how PFOF works.

Markets Without Payment for Order Flow

So let’s say Gensler gets his way and PFOF is banned. What then?

For one, commissions may come back. There is a chance this may happen, but it’s unlikely. Too many large brokers can exist just fine without commissions.

Realistically, brokers may decide to “internalize” their order flow. These orders will never see competition. Technically, they must provide the best execution. However, the fills from internalization may be more nebulous than with PFOF!

In-house exchanges may be established, and investors may have to pay a fee to trade on these exchanges. Again, the markets here will not be as liquid nor as good as they are at present.

No matter how it plays out, investors will pay for a ban on PFOF, either through fees, commissions or in wider spreads and poorer liquidity.

PFOF Ban: Win-Win for Hedge Funds?

So what happens to the “villain” in this tale?

During an interview at The Economic Club of Chicago, the CEO of Citadel, Ken Griffin, said, “Payment for order flow is a cost to me.”

Mr. Griffin seems happy for a ban; after all, this will only mean Citadel can fill the same orders without paying!

But does Mr. Griffin truly want to do away with PFOF? What will actually happen at Citadel? We can’t say for certain. Perhaps his rhetoric is all strategy. All we do know is that a PFOF ban will most likely hurt the retail investor.

PFOF: What's the Solution ?

What’s the answer?

PFOF is built mostly on a system of trust. It assumes we trust our broker. Even though by law brokers most get us the best fill, we have no transparent way of knowing for certain whether or not they do.

Most Americans have an inherent distrust of Wall Street. This is in our blood. We will never take a Wall Street executive at their word. The only solution, that I can see, is to find a method of promulgation that removes the veil of ambiguity around PFOF.

Can they prove, clearly and on a regular basis, that they are indeed getting us the best fills?

But net-net, at the end of the day, empirical research has proved the system ain’t broken. Why fix it?

Next Lesson

Additional Resources

Payment for Order Flow (PFOF) – Investopedia

Payment for order flow – Wikipedia

Differences Between Invesco’s QQQ, QQQM, and QQQJ

Posted on October 4, 2021February 11, 2022 by Mike Martin

Last updated on February 11th, 2022 , 01:11 pm

	QQQ	QQQM	QQQJ
Fund Name	Invesco QQQ Trust	Invesco NASDAQ 100 ETF	Invesco NASDAQ Next Gen 100 ETF
Category	Large Cap Growth	Large Cap Growth	Mid Cap Growth
Index	NASDAQ-100 Index	NASDAQ-100 Index	Russell Mid Cap Growth
Expense Ratio	0.20%	0.15%	0.15%
Average Stock Market Cap	$828 Billion	$828 Billion	$22 Billion

Highlights

QQQ, QQQM, and QQQJ are all funds issued by Invesco
QQQ and QQQM are almost identical, with QQQM having lower fees
QQQJ focuses on Nasdaq up-and-coming companies
QQQ and QQQM companies have an average market cap of $825 billion
QQQJ companies have an average market cap of $22 billion

The name Invesco has become synonymous with investing in the Nasdaq. This is due mainly to the most senior and popular fund on our list, the Invesco QQQ Trust, or simply, the “Q’s” (QQQ). This Nasdaq-100 index tracking fund consistently ranks within the top-performing ETFs in the US.

With over $180B in assets under management, the QQQ fund is large, liquid, and provides exposure to some of the most explosive tech companies in the US.

However, in recent years, the growth of the companies within the Nasdaq-100 has slowed relative to their smaller capitalized peers.

Introducing Invesco's QQQJ ETF

In order to provide investors exposure to these younger up-and-coming Nasdaq companies, Invesco recently created the NASDAQ Next Gen 100 ETF under the ticker QQQJ. The companies within this fund have an average market cap of $22 billion.

In contrast, companies within the QQQ fund have an average market cap of over $825 billion.

What is Invesco's QQQM ETF?

Invesco’s wildly popular QQQ ETF (mentioned above) was launched back in 1999. In 2020, Invesco launched two additional funds: QQQJ and QQQM. The latter fund is called the Invesco NASDAQ 100 ETF.

In almost every way, the QQQM ETF is a mirror image of the older and more liquid QQQ fund. They provide the same exact exposure to the Nasdaq-100. There are only three minor differences.

When compared to the QQQs expensive ratio of 0.20%, QQQM charges only 0.15%.
QQQ tends to offer slightly better liquidity than QQQM, but not enough to make up for the additional 0.05% in fees
QQQ is structured as a trust; QQQM is structured as an ETF (this makes no difference to us)

Invesco's QQQ Explained

As of 2021, Invesco’s QQQ ETF has ranked as the 2nd highest traded ETF in the US. So what is it about this ETF that garners so much attention?

Here is how Invesco describes their fund:

Though stated as an exchange-traded fund (ETF), QQQ is technically a unit investment trust (UIT), which should make very little difference to us.

There is a very good reason behind the QQQ’s seemingly inexorable rise.

With the exception of a few years, the US stock market has been broadly in a bullish market since QQQs birth in 1999. During bullish markets, growth companies tend to outperform value companies.

As a result of this, the returns of indexes that include value companies (such as the S&P 500 index) pale in comparison to the growth-heavy companies within the Nasdaq-100.

Take a look at the below 5-year chart comparing State Street’s SPDR® S&P 500® ETF Trust (SPY) to Invesco’s QQQ Trust (QQQ).

SPY vs. QQQ - 5 Year Cart

During bullish markets, QQQ appears to be the better choice. During bearish markets, QQQ tends to sell off more rapidly than SPY.

Additionally, since Nasdaq companies are more growth-focused, they rely more upon loans for financing. In an environment of rising interest rates, QQQ may very well underperform SPY, even during bullish markets. This has been proved throughout 2021.

So what companies constitute such stellar performance? Let’s next look at the top ten holdings of QQQ.

Invesco QQQ Top Ten Holdings

Is QQQ a Good Investment?

Given the risks that we mentioned above, Nasdaq’s QQQ fund appears to be a great investment for investors who can handle volatile swings. These are generally investors who have long-term investing horizons.

Since Nasdaq tends to underperform the overall market during downtimes, the index is not well suited for investors on the cusp of retirement. Of course, having some exposure to the Nasdaq is a great diversification strategy for all investors.

However, before you choose to invest in QQQ, make sure you first understand the nature of QQQM.

Hint! When offered the choice between investing in QQQ and QQQM, QQQM is the better option for the vast majority of retail investors. Read on to see why.

Unfortunately, there are few Nasdaq funds offered through employer-sponsored 401k plans. A great way to provide exposure to the Nasdaq is therefore through more self-managed IRA’s, such as a Roth or Traditional IRA

Invesco’s QQQM Explained

In 2020, Invesco launched the Nasdaq-100 ETF, QQQM. Here is how Invesco describes their ETF:

Sound familiar to QQQ? The funds are almost identical.

The main difference to you, the investor, is that QQQM charges a management fee of 0.05% lower than QQQ.

When given the choice between investing in QQQ and QQQM, QQQM wins here for the vast, vast majority of retail traders. Though QQQ provides for marginally better liquidity, this does not make up for the 0.05% additional fees that QQQ charges over QQQM. QQQ simply has greater name recognition.

Invesco QQQM Top 10 Holdings

The companies which comprise QQQM are identical to QQQ, including their respective weightage.

Invesco’s QQQJ Explained

Invesco launched their NASDAQ Next Gen 100 ETF (QQQJ) in 2020. Here is how Invesco describes their fund:

The main difference between QQQJ and QQQ/QQQM lies in the companies which constitute the fund.

QQQ/QQQM invests in the largest 100 companies in the Nasdaq. By reading the above quote, we can see that QQQJ invests in none of these companies, but the 101st-200th largest companies in the Nasdaq. Many of these companies are “mid-caps”.

What does this mean to you?

QQQJ Has Greater Risk than QQQ/QQQM

Generally speaking, smaller market caps coincide with greater risk. Since every one of the stocks within the QQQJ ETF is smaller than QQQ/QQQM, QQQJ in theory should have great market risk, as well as reward.

Since QQQJ is a relatively new fund, it is difficult to put this theory to the test. 2021 has been a choppy year for the markets. With volatile interest rates, everything in the Nasdaq space has been thrown out of whack. With that being said, let’s take a quick look at how QQQJ has compared to QQQ.

Chart from Google Finance

Invesco QQQJ Top Ten Holdings

So what companies does QQQJ invest in? You probably recognized many, if not all of the top ten companies within the QQQ/QQQM funds.

You probably won’t have the same familiarity with the top ten QQQJ companies. Remember, the goal of QQQJ is to invest in the next big thing. If all goes as planned, the names of some of these companies will be just as familiar as those of the QQQs in the future.

Is QQQJ a Good Investment?

We mentioned earlier that when compared to the S&P 500, the Nasdaq-100 (QQQ/QQQM) generally has greater market risk. Therefore, when compared to QQQ, QQQJ has a greater risk.

It is because of this QQQJ is best suited to investors with very long-term horizons, or for those investors who prefer more risk-on investing.

QQQ vs QQQM vs QQQJ: Sector Exposure

So far, we have focused on the differences between QQQ/QQQM and QQQJ. In truth, these funds are more alike than they are different. This similarity is best illustrated when looking at the sectors these three funds invest in. Let’s compare them below.

Sector allocation is massively important when it comes to investing. The reason QQQ has outperformed SPY by such a wide margin in recent years is due exactly to this. All of Invesco’s funds on this list have more than 40% of their funds directed in the information technology sector. Take a moment to study the below images to see the other exposures our three funds have.

Take note that the sector allocation for QQQ/QQQM is almost identical. In theory, they should be identical.

QQQ Sector Allocation

QQQM Sector Allocation

QQQJ Sector Allocation

Additional Resources

QQQ vs. QQQM vs. QQQJ: The Street

Equity REITs vs Mortgage REITs + 13 Best Stocks

Posted on September 26, 2021March 2, 2022 by Mike Martin

Last updated on March 2nd, 2022 , 10:24 am

REITs for Beginners

Real estate investment trusts (REITs) offer investors a great way to diversify their equity holdings. In the past, investing in real estate was a time-consuming and cumbersome process. Today, with the introduction of exchange-traded REITs, investing in real estate is only a few clicks of your mouse away.

According to the Internal Revenue Code (IRC), a business must meet the below criteria in order to qualify as a REIT:

Receive at least 75% of gross income from real estate. This includes real property rents, interest on mortgages financing the real estate property or from sales of real estate property
Invest at least 75% of total assets in real estate or cash
Have at least 100 shareholders at the termination of the trust’s first year
No more than 50% of its equity shares are held by five or fewer investors

If an investment company does indeed meet the above criteria, that business will be considered a REIT. They are therefore considered a “pass-through” business, which has added tax benefits.

Though owning real estate outright may be more tax advantageous than investing in REITs, REITs do come with their own tax advantages when compared to traditional equity investing. Let’s explore the tax implication of a “pass-through” business next. (Taxation can be fun when you learn about NOT paying taxes!)

Pass-Through Companies

Pass-through businesses (which qualified REITs are) pay ZERO corporate tax on their profits.

For example, let’s say that you are invested in JNJ stock. Before JNJ pays you a dividend, JNJ must pay corporate taxes on these proceeds. With REITs, however, the proceeds are passed on without JNJ ever paying this tax (which is currently 21%). This means more money for you!

So that’s taxation on the corporate level; what about on the individual level?

REITs Advantage for Individual Tax Rate

Investors in REITs can also save money on the individual tax level. So long as the business qualifies as a REIT, investors can take advantage of a 20% rate reduction to individual tax rates on the ordinary income portion of these distributions.

Now that we understand a little more about REITs, let’s take a look at a few of their advantages when compared to traditional real estate investments.

REITs Advantages Over Traditional Real Estate

Traditional real estate management requires extensive hands-on maintenance. With REITs, you’ll never have to worry about repairing the roof or unclogging a toilet!

Perhaps the most awkward and tedious job of the landlord is collecting rent. With REITs, you never have to worry about chasing down tenants, nor do you need to worry about eviction scenarios should you have tenants who can’t make the payments.

The process of buying and selling real estate introduces great inefficiencies. You never know the exact price you can purchase property for, nor will you know for sure what you can sell that property for. With REITs, all you have to do is click “sell” and your position is liquidated at the current market price.

Many real estate investors take on loans or mortgages to purchase their properties. Rent payment is often used to pay off debt. In a scenario where you can either not rent the property, or your tenant can not pay the rent, you may be at risk of defaulting on your loan. This may result in a poor credit score that could tarnish your future plans.

If an individual owns investment property across numerous states, tax time can be a nuisance. With REITs, however, you do not have to file income taxes for every state. This can save a lot of time and money, not to mention headaches!

So now that we know a little bit more about REITs, let’s explore the two different types of REITs; Equity REITs (eREITs) and Mortgage REITs (mREITs). Additionally, we will do an overview of “blended” REITs, which, you guessed it, offer a combination of the two.

With Equity REITs being the more popular option, let’s take a look at them first.

What are Equity REITs?

Equity REITs (eREITs) – reits.com – are indirect investment vehicles that invest in tangible real estate. They make their money from rental income derived from a pool of real estate investments.

This income is passed on to investors through dividends (the tax advantages of which we touched on earlier). Additionally, equity REITs allow for share price appreciation. When the value of an eREITs holdings rises, so does the value of your stock position. This is in addition to your monthly dividends.

So what exactly do eREITs invest in? Pretty much anything. Here are a few of the more popular categories.

Office REITs
Industrial REITs
Retail REITs
Lodging/Resorts REITs
Residential REITs
Self-storage REITs
Timberlands REITs
Health Care REITs
Data Centers REITs

Why to Invest in Equity REITs

Equity REITs offer investors many advantages. Let’s look at a few of them now.

Rental income is one of the most reliable sources of income. It doesn’t matter what market cycle we are in, when the rent comes due we (must of us anyway!) must pay.

Real estate can be a shady business. I just moved into a high-rise that I recently discovered is going to require brand new copper pipes in the near future. With REITs, you don’t have to worry about the nitty-gritty of property. Investing on the corporate level allows for great transparency.

In addition to having comparable returns when compared to stocks, equity REITs have less exposure to volatility, allowing investors more peace of mind.

Over time, equity REITs can appreciate in price quite a bit. Some have even beat the stock market. This isn’t the case with Mortgage REITs (which we will get to soon!).

Most equity REITs trade on exchanges, making the process of entering and exiting positions very seamless.

Equity REIT Risks

No investment comes without risks. Though the risk that comes with investing in equity REITs is relatively low, there are indeed some risks.

Sometimes the housing market finds itself in a bubble, and just as many times, that bubble bursts. When the value of real estate falls dramatically, the value of equity REITs will fall with them. Therefore, it may be wise to avoid investing in equity REITs when housing markets are teetering near all-time-highs, as they are presently in 2021.

In order to purchase properties, equity REITs must borrow money. These loans are subject to long-term interest rate risk. When interest rates rise, so do yields. The higher the yield, the lower the value of the REIT. You can look at the 10 or 20-year treasury as a good benchmark for equity REIT interest rate risk.

Before investing in an equity REIT, it is important to understand the properties that that particular REIT invests in. There are over 1,000 REITs. Some of these have very narrow scopes. For example, if you were invested only in timberland REITs, you may experience higher volatility due to the narrowness of the fund.

Now that we know what eREITs are, let’s explore a few promising equity REITs!

Best Equity REITs

Ticker	Company	Dividend Yield	Sector
AMT	American Tower	1.73%	Communications
UMH	UMH Properties, Inc	3.12%	Home Communities
STAG	Stag Industrial Inc	3.49%	Warehouses
HTA	Healthcare Trust of America, Inc.	4.27%	Medical Office Buildings
DEA	Easterly Government Properties Inc	5.02%	Government Facilities

What are Diversified Equity REITs?

Equity REITs can either invest in a single sector or diversify their holding across numerous sectors. Diversified REITs (reit.com) own and maintain two or more of the property sectors we listed earlier.

Generally speaking, the more diversified your portfolio is, the better. The most successful property investors have holdings across numerous sectors. If you can diversify in the REIT space for no additional cost, why not?

Here are a few of the more popular diversified eREITs.

Best Diversified Equity REITs

Ticker	Company	Dividend Yield	Sector
DBRG	Digitalbridge Group Inc	6.74%	Digital Infrastructure and Real eEtate
PW	Power REIT	No-Dividend	Greenhouses, Solar Farm Land and Transportation
OLP	One Liberty Properties, Inc	5.69%	Industrial, Retail and More

What are Mortgage REITs?

Mortgage REITs (mREITS) – reit.com are unlike equity REITS in that these funds do not actually own the property. Mortgage REITs make money by providing financing for both commercial and residential properties.

They accomplish this by both investing in and owning mortgages. They rely on short-term financing to do this, and in turn loan this money out at higher rates. The difference, or “spread”, is passed onto the shareholder in the form of dividends.

Why Invest in Mortgage REITs?

Since mREITS don’t invest in tangible real estate, the price of these funds is not at the mercy of the housing market. Of course, there are risks, just no direct risks pertaining to housing cycles.

mREITs usually pay higher dividends than equity REITs. Income thirsty investors not seeking capital appreciation may be attracted to mREITs for this reason.

The loans which constitute many mREITs are backed by agencies. Because of this, default risk can be minimalized.

Like equity REITs, most mortgage REITs trade on exchanges, thus making the process of entering and exiting positions very seamless.

Mortgage REIT Risks

Mortgage REITs are inherently more risky than equity REITs. This is mainly because of the high-risk nature that comes with short-term lending. Let’s next explore this specific risk, as well as a few other mREITs risks.

Just like Equity REIT, Mortgage REITs have interest rate risk, but of a different kind. Mortgage REITs typically loan money for their businesses at short-term interest rates (remember, equity REITs borrow at the long-term interest rates).

Mortgage REITs make money from mortgage payments. As long as the interest rate on these long-term mortgages is higher than the short-term rate they borrow at, they will make the difference in profit and pass that on to you, the shareholder.

But what happens when short-term interest rates spike higher? The spread narrows and the income of mortgage REITs go down, thus resulting in a lower dividend for you.

However, most mREITs hedge against this risk using financial instruments such as options contracts.

The dividends of equity REITs are derived from a steady stream of rent income. The dividends of mortgage REITs are subject to short-term interest rates, which are volatile and in constant flux. This results in less reliable dividend payments.

But what happens when short-term interest rates spike higher? The spread narrows and the income of mortgage REITs go down, thus resulting in a lower dividend for you.

However, most mREITs hedge against this risk using financial instruments such as options contracts.

In order to fund new investments, mortgage REITs are known to issue new stock. When new stock is issued, the value of pre-existing shares goes down in value. And who wants the value of their stock to go down!

Let’s now take a look at a few of the more popular mortgage REITs.

Best Mortgage REITs

Ticker	Company	Dividend Yield	Sector
NLY	Annaly Capital Management, Inc.	9.93%	Very Diversified
NRZ	New Residential Investment Corp	8.90%	Very Diversified
PMT	PennyMac Mortgage Investment Trust	9.36%	Home Loan Lender
CIM	Chimera Investment Corporation	8.55%	Residential Mortgage Loans
AGNC	AGNC Investment Corp	8.85%	Agency Backed MBS (Mortgage-Backed Securities)

Equity REITs v Mortgage REITs

In a nutshell, mREITs tend to be more risky than eREITs. This is mainly due to mREITs exposure to short-term interest rate risk.

The below table highlights some of the main differences between eREITs and mREITs

	Equity REITs	Mortgage REITs
Interest Rate Risk	Moderate: Long-Term Rate Risk	High: Short-Term Rate Risk
Business Revenue	Rental Income on Commercial Real Estate Property	Loaning Money in Commercial and Residential Properties
Shareholder Value	Price Appreciation and Income	Income
Share Dilution Risk	Low	High
Dividend Yield	High	Very High
Overall Risk	Moderate	Moderate to High

What are Hybrid REITs?

If you’re interested in investing in both equity REITSs and mortgage REITs, hybrid REITs allow you to do this by investing in a single fund.

Hybrid REITs combine the strategies of equity and mortgage REITs. These funds both buy properties and finance real estate. They offer the benefit of both categories while simultaneously reducing risk in the form of diversification.

Transcontinental Realty Investors (TCI) and Simon Property Group Inc (SPG) are two popular hybrid REITs.

Final Word

REITs offer diversification seeking investors a great opportunity to expand their portfolio. It is important to remark that not all REITs are created equally. 2020-2021 proved that. Retail, hotel and office REITs plummeted on the tail of Covid-19. A few did not survive.

Having a general pulse of the real estate market is crucial before investing in a REIT fund. Make sure to always check the historical share and dividend performance before investing. Although past results are not indicative of future performance, this is a great starting point.

Recomended Reading

Additional Resources

5 Types of REITs & How to Invest in Them – Investopedia

5 Way VXX Options Differs from VIX Options

Posted on September 21, 2021April 9, 2022 by Mike Martin

Last updated on April 9th, 2022 , 06:43 am

In 2022, volatility products have been exploding in popularity. There are two catalysts behind this drive:

However, getting started with trading volatility can be a daunting process. There are numerous ETFs out there that track volatility, all in their own unique way.

Two of the most popular volatility products are the exchange-traded note (ETN) VXX (iPath® Series B S&P 500® VIX Short-Term Futures) and the VIX Index (CBOE Volatility Index).

The first thing to understand is that these two products have very different investment strategies; they should not be used interchangeably. While both track volatility indexes, there are some huge differences between them.

In this article, projectfinance will go over the main differences between these two products. Additionally, we’ll explain the benefits of volatility products as well as the similarities that both VIX and VXX share. Let’s get started with our comparison chart below!

VIX vs VXX

	VIX	VXX
Settlement Method	Cash Settled	Physical Delivery (Stock Settled)
Style	European	American
Underlying	S&P 500 options	VIX Short-Term Futures
Profound Time Decay	No	Yes

Let’s start off by looking at the definition of these two products, as well as their respective histories.

VIX Definition and History

VIX Definition: The “VIX”, also known as the “Fear Index”, is the ticker symbol for the Chicago Board Options Exchange’s CBOE Volatility Index. This index measures the market’s expectations for volatility over the proceeding 30 days based on near-term S&P 500 index options.

VIX does not offer stock, but it does offer futures and options trading.

VIX History: The VIX is the oldest and most popular volatility product. The VIX was conceived in 1990. Futures on the VIX began trading in 2004; options on the VIX were first offered in 2006.

VXX Definition and History

VXX Definition: The iPath® S&P 500 VIX Short-Term Futures (VXX) is an exchange-traded note offered by Barclays PLC. Unlike ETFs, ETNs are “fixed income” securities and therefore must track the performance of their representative index; there is no tracking error. However, it is a futures-based ETF, which carries significant risks.

This volatility “ETN” tracks the short-term futures of the VIX with 30 days to expiration. However, there is no futures contract on the VIX that is always 30 days to expiration; the dates constantly change. To remedy this, Barclays utilizes two futures contracts (front-month and the proceeding month), and constantly adjusts the respective position sizes so the net days-to-expiration is 30 days.

Unlike VIX, VXX does have underlying stock which you can trade.

VXX History: Barclays VXX first began trading in 2009. This particular “series” shut down in 2019. Later, another version of VXX was launched by Barclays, called VXX series B, which trades under the old ticker of VXX.

VXX vs VIX Fundamental Difference

Before we get started, let’s first examine the roots of our two products.

The key to understanding the difference between these two products lies in their composition: the VIX is formed with S&P 500 options; VXX is formed with VIX futures. Therefore, you can think of VXX as a sort of “derivative of a derivative”, not to get too “Inception” on you!

3 Reasons to Trade (or Monitor) Volatility

Before we get into the differences between VXX and VIX, it may be helpful to first understand the reasons behind their popularity. Unlike stocks, volatility does not appreciate in value over the years, nor do volatility products pay dividends. So why do investors trade volatility products?

1. Volatility as a Market Hedge

Volatility products were created as a way for traders to mitigate risk. How?

Let’s say that you own 100k worth of stock in the SPY ETF. You are a senior investor and worry that the unemployment number coming out tomorrow may have an adverse effect on your portfolio. However, (perhaps because of tax reasons) you don’t want to sell any of your stock. Instead, you could purchase an equivalent amount of call options in the VIX. That way, if the “fear index” skyrockets, the appreciation of your VIX calls will help offset any losses on your stock.

Note! More advanced traders may wonder why it is traders who want a hedge don’t directly purchase “put” options on the product (like SPY Puts) instead of VIX “call” options. The answer? Volatility indexes tend to rise disproportionately higher during market sell-offs. It isn't uncommon for the VIX to be up 8% on days when the market is down only 1%, thereby making your VIX call a greater hedge than a SPY put.

2. Trading Volatility (VXX and VIX) for Stock Market Speculation

Though volatility products offer investors a great way to hedge, most contracts traded in VXX and VIX (particularly VXX) are the result of traders speculating on market direction. Professional traders love to “sell volatility”. When volatility is sold, traders profit when the index (VIX) or ETN (VXX) either stays the same or goes down in value. This is typically what happens in normal markets, thereby it is a consistent way to generate income.

However (and a big however), this strategy certainly isn’t the only one; one trader nicknamed “50 cent” on the CBOE loved buying out-of-the-money calls on the VIX. He executed this strategy for one year, slowly accumulating painstaking losses.

And then, one week, following a steep market sell-off, 50 cent racked in a $200m profit!

Selling volatility usually makes money, but if you’re not hedged and the market goes south fast, watch out! 50 cent is waiting for you.

3. Volatility Index’s Provide Value for Everyone

You don’t have to trade volatility products in order to take advantage of their utility. The VIX index is a great indicator of market uncertainty. If you’re the owner of a portfolio of stocks and wish to get a window into the future predicated moves of the market, the VIX is a great tool. It is the most reliable index for stock market volatility in the world.

Similarities of VIX and VXX

Before we get into how VXX and VIX differ, let’s explore some of the similarities of the two. After all, VXX and VIX are more alike in nature than they are different. Here are three similarities:

Both VXX and VIX rise in value during steep market declines.
In the short-term, price movement tends to be relatively synchronized between the two (but not always!). Take a look at the graph below. (Later we will look at a 3-year graph comparing the two).

3. Implied Volatility (IV) on Volatility Products

The “IV” of traditional indexes and equities tend to go down with further out-of-the-money strike prices. Volatility products, however, act just the opposite: the implied volatility on VXX and VIX both rise with higher strike prices. Take a look at the below screenshots from the tastyworks platform comparing the IV on the VIX and SPX (which tracks the S&P 500).

5 Differences Between VIX and VXX

Let’s now explore the most important part of this article: the 5 difference’s between the two products!

1. VXX Price Decays Faster Than VIX

Though VXX and VIX have a lot in common, they are verily not the same products. We spoke earlier about the composition of the two products: VIX is composed of S&P 500 options; VXX is composed of futures contracts on the VIX. The result for VXX is a “synthetic” futures contract. This results in inefficiency.

Take a look at the below chart, which compares VXX to VIX over a duration of three years.

Over the course of 3 years, VIX rose 59% in value while VXX dropped over 70%. So why such a drastic difference in return?

Historically, VIX futures (which VXX comprise) are priced at a premium to the index, particularly futures that settle more than 30 days away (which VXX also encompasses). However, as expiration nears, that premium begins to decay. The resulting price action can result in futures on the VIX losing more in value than the respective index.

Though this price differential isn’t a lot over the short-term typically, the above graph shows us just how devastating it could be to investors long VXX over time.

2. VXX and VIX Are Made of Different Underlying's

The CBOE’s VIX index is constructed using the implied volatility on SPX options. These options are “front-month”, and represent the market’s expected move for the proceeding 30-days.

Barclays VXX ETN is based on VIX short-term futures. Since there is never a constant future contract with 30 days until expiration, VXX uses a combination of the two front-month VIX futures in order to synthetically mirror a perennially 30-day future contract.

3. VXX and VIX are Styled Differently

All options are either styled American or European.

European Style Options

VIX options are “European” style (Investopedia). This simply means that options traded on VIX do not allow for early assignment/exercise. However, this doesn’t mean you can’t exit a long position in VIX before expiration, you simply can’t exercise your contract before expiration.

This is an added benefit for trader’s short options in VIX; since early exercising is not allowed, you will never have to worry about being assigned before expiration!

American Style Options

VXX options are “American” Style (Investopedia). This means that the owner of a VXX option (call or put) has the right to exercise their option contract at any time (though this rarely happens when extrinsic value is on the table).

We mentioned earlier that VIX has no tradable stock. Therefore, what do you actually deliver if you choose to exercise your option or are assigned at expiration?

That brings us to our next difference:

4. VIX is Cash-Settled; VXX is Physical-Delivery

Most European-style options are cash-settled. Most American-style options require physical delivery upon settlement. This stays true for VIX and VXX.

Cash Settled Options Definition (VIX): A settlement method used in options trading that does not require delivery of the underlying shares. Instead, a simple transfer of cash takes place which corresponds to the closing intrinsic value of the options.

Therefore, VIX options are settled via an exchange of cash.

Physical Delivery Options Definition (VXX): A settlement method in options trading that does require delivery of the underlying shares is “physical delivery”. When options are assigned and exercised under this method, shares of stock (typically 100 shares per options contract) are exchanged.

Long/short call options under this method will buy/sell shares (respectively) of the stock at the strike price of the option. Long/short put positions will sell/buy shares of the stock at the strike price of the option.

Unlike VIX, Barclays VXX product does indeed offer stock. Underlying’s that offer stock are settled in stock. All option contracts in VXX are settled via physical delivery of the underlying ETN.

5. VXX Allows for the “Contango” and “Backwardation” Trade

Though VXX’s strategy to use two months of future contracts creates some inefficiency, it also offers traders some benefits, such as the “contango” and “backwardation” trade – CME.

Backwardation Definition: Backwardation occurs when the price of a futures contract is trading at a discount to the expected spot price at expiration.

Contango: Contango occurs when the price of a futures contract is trading at a premium to the expected stock price at expiration.

In times of market distress, such as during the early days of the pandemic, the short-term forecast for a market is more uncertain than the long-term forecast. This leads to backwardation.

Conversely, in a confident market, contango is often the resulting effect on future prices.

Traders in VXX can take advantage of these two market events by participating in “arbitrage”. This is a very complex process and requires much research.

Final Word

At first glance, VXX and VIX may seem to be very similar in nature. However, after putting the two products under the microscope, we can see there are some major differences between the two.

Retail traders love VXX. Let’s end by taking a look at a few of the advantages of VXX.

Next Lesson

Additional Resources

VIX vs. VXX Correlation – Seeking Alpha

VIX VERSUS VXX: A JOINT ANALYTICAL FRAMEWORK

17 Best Low-Priced Stock ETFs for Beginners with Little Money

Posted on September 17, 2021April 21, 2022 by Mike Martin

Last updated on April 21st, 2022 , 12:51 pm

Highlights

Most popular ETFs are priced at several hundreds of dollars; there are many low-cost funds that offer the same tracking for a greatly reduced price.
Many ETFs can be divided into large-cap, mid-cap, and small-cap. Generally speaking, the better capitalized a company is, the less risk they have (and reward).
It is important to note that “growth” ETFs generally have much more market risk than “value” ETFs or “blended” ETFs, which contain a combination of the two.

2022 is becoming the year of the exchange-traded fund (ETF). And it’s about time. ETFs offer investors perhaps the cheapest and best way to diversify their portfolios. Some broad-based ETFs (like Vanguard’s VTI) offers investors exposure to thousands of stocks. And all you have to do is buy one share!

However, many ETFs are not cheap. US stocks (equities) have been exploding in value lately. If you were to purchase every single stock within the S&P 500 on your own today, it would cost you $89,157,36.

I don’t know about you, but I don’t have that kind of money laying around. Even if I did, I don’t know if I’d want to spend the time not only entering the positions but constantly adjusting them to mirror the always-changing index!

This is where ETFs come in handy.

ETF (Exchange-traded fund) Definition: A security that trades on a stock exchange that tracks a particular set of pooled securities (like an index or a sector).

So instead of purchasing all of the 500 stocks in the S&P index, we could purchase an ETF that mirrors the index.

So how much would buying one share of an ETF representing the S&P 500 cost us? Below, I have listed the three most popular ETFs that track this index, along with their current market price.

SPY: SPDR S&P 500 ETF Trust $447.88

IVV: iShares Core S&P 500 ETF $449.90

VOO: Vanguard S&P 500 ETF $411.82

Affordable ETFs

So $400+ is still a lot cheaper than $89,157, but this article is about the best CHEAP ETFs, and $400 isn’t cheap to me! There are indeed cheaper options.

But are we giving anything up by going after some of the lower-priced ETFs? No! Many ETFs simply track indexes. As long as they do this accurately and for a reasonable fee (expense ratio) the price of the ETF shouldn’t matter. All but two ETFs on our list have insanely low fees of at or under 0.15%.

In addition to being more affordable to beginner investors, low-priced ETFs are also attractive to option traders who utilize the covered call strategy. In this strategy, you buy 100 shares of stock and sell (write) one call against this stock. When an ETF is trading over $400/share, you’ll need 40k+ just to do a one lot.

If you’re interested in learning more about options trading, please feel free to check out our video (or article), Options Trading for Beginners – 11m plus views, and counting!

Additionally, if you’d like to do a deep dive into the mechanics of how ETFs work, we have content on that as well. You can find both the article and the video below.

Market Cap Explained

Outside of the US, we have listed a few broad-based international ETFs. Within the US, our list spans across different “market caps” (capitalizations -Fidelity).

Market Cap (Capitalization) Definition: The total value of a company that is traded on the stock market. A company’s “market cap” is calculated by multiplying the total number of shares by the current share price.

So essentially, the market cap tells us the approximate net worth of a company. If you wanted to buy that company, that company’s cap is in the ballpark of what you would be paying. But since we’re talking about the cheapest ETFs out there today, we probably aren’t funded well enough to buy Apple.

A publicly traded company will always fall under one of three different market caps. We have listed top performers on our list from each of the below categories:

Companies with a relatively small capitalization of under $2 billion.

Companies with market caps that range between companies $2 and $10 billion in value.

Companies with market caps that exceed $10 billion in value.

Additionally, we have listed a few “broad-based” ETFs. These funds span across all market sectors and generally include the most companies within their baskets. If you are only going to buy one ETF and want a lot of diversification, broad-based (or “total market”) ETFs are the way to go!

Without further ado, let’s get to the list!

Broad-Based ETFs

Ticker	Fund Name	Market Price	Expense Ratio
SCHB	Schwab U.S. Broad Market ETF	$108.16	0.03%
ITOT	iShares Core S&P Total US Stock Market ETF	$102.49	0.03%
MOAT	Morningstar® Wide Moat Focus Index	$103.32	0.45%

Large-Cap ETFs

Ticker	Fund Name	Market Price	Expense Ratio
SPLG	SPDR® Portfolio S&P 500® ETF	$52.64	0.03%
JMOM	JP Morgan US Momentum Factor Index	$45.85	0.12%
VONG	Vanguard Russell 1000 Growth Index Fund ETF	$74.35	0.08%
SPYG	SPDR® Portfolio S&P 500 Growth ETF	$67.63	0.04%
QQQE	NASDAQ-100 Equal Weighted ETF	$86.85	0.35%

Mid-Cap ETFs

Ticker	Fund Name	Market Price	Expense Ratio
SCHM	Schwab US Mid-Cap ETF	$79.08	0.04%
MDYG	SPDR® S&P 400 Mid Cap Growth ETF	$78.43	0.15%
IJK	iShares S&P Mid-Cap 400 Growth ETF	$81.83	0.17%

Small-Cap ETFs

Ticker	Fund Name	Market Price	Expense Ratio
SLY	SPDR® S&P 600 Small Cap ETF	$94.98	0.15%
ISCV	iShares Morningstar Small Cap Value ETF	$57.22	0.06%
SCHA	Schwab U.S. Small-Cap ETF	$101.67	0.04%

Broad-Based International ETFs

Ticker	Fund Name	Market Price	Expense Ratio
VXUS	Vanguard Total International Stock ETF	$66.37	0.08%
SCHF	Schwab International Equity ETF	$40.25	0.06%
IXUS	iShares Core MSCI Total International Stock ETF	$73.47	0.09%

Growth vs Value Companies

In the above list, most of the ETFs employ the “blend” approach to investing in companies. This means the ETFs have within them both “growth” and “value” companies.

However, you may have noticed a few funds on the list are “growth” exclusively. Growth stocks are typically younger and more exciting companies, and tend to get the most attention in the ETF space. Think Zoom and NVIDIA here.

Opposite growth companies are “value” companies, which are well established, typically dividend issuing companies that are less volatile. Value companies have been around for a long time. A couple value companies are Johnson & Johnson and Campbell soup.

Growth Companies

Issues Small or No Dividends
High Beta = High Risk
Overvalued in Price
Earnings to Growth Ratio > 1

Value Companies

Typically Issues Larger Dividends
Low Beta = Low Risk
Undervalued in Price
Earnings to Growth Ratio < 1

Historically, growth stocks tend to outperform value stocks. This should make sense – since the US stock market has been historically bullish over the long run, more “risk-on” stocks, such as those that fall under the growth umbrella, should appreciate more in value than less risky securities.

Take a look at the below chart, which compares the total returns (meaning dividends are included) between growth stocks (orange) and value stocks (blue) over the past decade.

We can see in the last few years, on the tail of Covid and stay-at-home policies, growth companies really soared.

Traditionally, growth stocks rise higher in bull markets, and sink lower in bear markets when compared to value stocks. This pattern, however, may not hold true forever in the modern world.

Final Word

There are thousands of ETFs currently listed. Though projectfinance has picked through some of the top performers with the lowest fees, they may not be suitable for you.

Remember, there is more to an ETF than its performance. Before investing in an ETF on your own, make sure to follow the below checklist:

I have seen ETF expense-ratios higher than 5%. This means your investment has to make 5% on the year just to breakeven! Make sure to take the time to check this ratio before investing.

Issuers of ETFs have a fund information page, sometimes called a prospectus, that compares their fund with that of the representative index. For index-tracking funds, you ideally want a fund that closely matches the performance of the benchmark index.

The ease to enter and exit positions at a minimal cost is ideal. This is known as liquidity. This means high volume and tight bid-ask spread. The funds we listed are all very liquid.

However, not all ETFs are created equally. Years ago, I invested in an emerging market ETF to discover later the bid was $52 and the offer was $55. I could have lost up to 6% of my investment from simply entering and exiting a position! Make sure the spread between the bid and ask is tight, and the daily volume is high (preferably over 1 millions shares).

Additional Resources

9 Cheap ETFs for Cost-Conscious Investors | Investing

7 Low-Cost ETFs: Should You Invest? – Investopedia

7 Covered Call ETFs and How They Work

Posted on September 14, 2021April 19, 2022 by Mike Martin

Last updated on April 19th, 2022 , 01:00 pm

7 Best Covered Call ETFs and How They Work

The covered call strategy is a great way for risk-averse investors to make passive income in a sideways market.

For those who already have a solid understanding of how covered calls work, we have provided a list of some of the best covered call ETFs below.

For those who aren’t 100% certain about the mechanics of covered calls (each one is different!), please read on as understanding these various strategies is vital to understanding their performance.

Lastly, I would like to add that most covered call ETFs are NOT passive investments. The “set-it-and-forget-it” approach does not work here. Why?

Over time, covered call ETFs tend to massively underperform the market. If you are looking at a long time horizon (such as retirement), history tells us the best approach to investing in equities is outright. However, if your time horizon is relatively short, and you are either neutral or slightly bearish on the market, covered calls may provide a great way for you to make some extra money.

Without further ado, here’s our list! Remember, there is A LOT more to these ETFs than their dividend! A fat dividend usually coincides with forfeiture of price appreciation.

Please read on if you have any questions as they will most likely be answered.

7 Top Covered Call ETFs

Ticker	Fund Name	Dividend Yield	Strategy	Option Strategy	Expense Ratio
XLYD	Global X S&P 500 Covered Call ETF	9.12%	Income	Sells at-the-money calls	0.60%
QYLD	Global X Nasdaq 100 Covered Call ETF	9.92%	Income	Sells at-the-money calls	0.60%
RYLD	Global X Russell 2000 Covered Call ETF	12.09%	Income	Sells at-the-money calls	0.60%
XLYG	Global X S&P 500 Covered Call & Growth ETF	0.78% 30-day SEC Yield (new fund)	Income + Price Appreciation	Sells at-the-money calls on 50% of portfolio	0.60%
QYLG	Global X Nasdaq 100 Covered Call & Growth ETF	0.08% 30-day SEC Yield (new fund)	Income + Price Appreciation	Sells at-the-money calls on 50% of portfolio	0.60%
GLDI	X-Links™ Gold Shares Covered Call ETN	9.77%	Income + Price Appreciation	Sells out-of-the-money calls	0.65%
KNG	FT Cboe Vest S&P 500® Dividend Aristocrats Target Income ETF	3.40%	Income + Price Appreciation	Sells at-the-money calls on 20% of portfolio	0.75%

Want to skip over the covered calls tutorial and jump directly to an explanation of the above ETFs? Click Here!

Understanding Covered Calls for Beginners

The covered call option strategy is defined as the following:

Covered Call: A financial transaction where a call option is sold against an underlying security, typically 100 shares of stock.

Components:

Long 100 Shares of Stock
Short 1 Call Option

For a complete lesson on covered calls, please make sure to check out either our video or article on the subject.

Covered Call Example

In order to understand the utility of covered calls, let’s take a look at a quick example.

Let’s say you own 100 shares of Invesco’s QQQ ETF, which represents the Nasdaq 100.

In this scenario, let’s assume QQQ has been reaching all-time highs every day. You think the ETF is in for a breather and will trade sideways for some time. The current price of QQQ is $375/share.

With stock, there is no way you can capitalize off of your projected market direction. However, if you utilize options, you can make a little extra money off of a neutral share price. How?

By selling a call. Let’s say that you do not believe QQQ is going to trade above $380/share for the next month. In this situation, you could sell a call option 30 days out at the 380 strike price. We’ll say you are able to sell it for $2.

What does that mean? As long as QQQ is trading below $380/share when your option expires, you’ll receive the full credit of $2, or $200. However, if the ETF rallies to, let’s say, $390/share, you will miss out on this price appreciation.

When you sell a call against your stock, the most you can ever make is strike price + premium sold. In our case, once the stock goes above (380+2) $382/share, we won’t see any additional gain. For every dollar we make on the stock at these levels, we lose a dollar on the option.

Covered Call "Moneyness"

Covered calls can either be sold out-of-the-money, at-the-money, or in-the-money. In our above examples, all covered calls are sold at-the-money, or out-of-the-money (the traditional covered approach).

The “moneyness” of an option is determined by the strike price of that option relative to the stock price.

Here’s how that looks on a chart:

Covered Call Performance

Markets will always be in one of three states: bearish, neutral, or bullish. The covered call strategy will profit in 2 (and sometimes 3!) of these markets.

1. Covered Call in a Bullish Market

Covered calls typically do not fare too well in a bullish market. This depends, of course, on the strike price of the call sold! If you sell an at-the-money option, you will likely miss out on price appreciation if the underlying rallies. If you sell an out-of-the-money option, and the stock doesn’t reach the strike price of the call you sold, you will win on both the income received as well as price appreciation!

2. Covered Call in a Neutral Market

Covered calls love neutral markets. In this scenario, you won’t miss out on any price appreciation. While everybody else is flat, you’ll be making a nice dividend!

3. Covered Call in a Bearish Market

Like covered calls in a bullish market, what really dictates how well a covered performs in a bear market depends on how bearish that market is.

For a minorly bearish market, the call we sell provides us some downside protection. Just subtract the premium you received from the stock price, and that’s where your losses begin to build up.

In a market correction, however, watch out! Though covered calls mitigate risk, they by no means irradicate risk; you still have A LOT of downside risk!

Let’s next look at a few pros and cons of covered call exchange-traded funds (ETFs).

Covered Call ETF Pros

1.) Income Generation

Selling a call option against your long stock creates a steady stream of income for your portfolio. Generally, covered call ETFs pay out dividends on a monthly basis, as that is the frequency that they sell calls.

The further out of the money the call you sell is, the less premium you will receive. Some covered call ETFs, like QYLD, sell at-the-money calls. That is the reason their dividend is so high. But remember, the closer the strike price is to the stock price, the less you’ll make when the stock rallies.

2.) Profit in a sideways market

With markets teetering near all-time highs, many investors believe we are in for a breather. The covered call strategy allows you to capitalize in a neutral market. If the market goes nowhere, you will collect the full premium on the call you sold.

3.) Covered Call ETFs may save time and money

Trading options is a very complex and time-consuming process. After working as an options broker in Chicago for 15 years, I can tell you that the education never stops. Investing in covered call ETFs gives you peace of mind; you don’t have to worry about “rolling” positions, nor do you have to worry about whether or not you are assigned.

ETFs employ “price stabilizers” to keep the ETF price in check, as well as fund managers to actively manage the positions. This does, however, come at a fee – most covered call ETFs I have seen charge a fee of about 0.60%. Though high when compared to other ETFs (the popular SPY ETF fee is only 0.09%), these funds certainly earn their money. Remember, trading options can be a costly endeavor in terms of time and commissions.

4.) Covered Call ETFs allow for great diversification.

A lot of the funds on our list go out and actually buy all of the securities within the index. That’s a lot of work! Can you imagine how much it would cost to buy all of the stocks within the Nasdaq 100 on your own?

5.) Covered Call ETFs have no assignment risk

When you are trading covered calls on your own, you are at risk of being assigned on your short call at times when the extrinsic value is low, or when the underlying issues a dividend (dividend risk). ETF managers take care of this for you, mostly by selling capitalize in a neutral market (European style options) which have no early-assignment risk as opposed to options on traditional stocks and ETFs (American style options).

Covered Call ETF Cons

1.) Upside limited to strike price + premium sold

Covered calls are not great investments for bullish markets. That is assuming an alternative for your investment strategy was to invest directly in the stock. After the stock surges beyond your strike price + premium sold, you will see no additional profit.

2.) Covered calls have massive stock risk

Though the covered call strategy does indeed limit the risk of an equity position, it by no means eradicates that risk. After you account for the discount of the premium you sold, a covered call loses money on a 1:1 basis with the stock.

3.) Poor performance in volatile sectors

The more volatile the underlying, the higher the dividend you will receive. But trading covered calls in very volatile sectors, such as energy, can wipe your account out. How?

Let’s say oil is trading at $100 a barrel and you own an ETF that matches this price, meaning the ETF tracks oil and is currently trading at $100/share. Let’s say oil plummets to $20/barrel. If you took in $5 for an at-the-money-call when the stock was at $100, your max loss would be $95/share. Your at-risk expose is still $95/share!

But that’s ok, because when oil rallies, you’ll be included in it, right? Nope. If you’re trading a covered call on oil, your upside IS LIMITED TO STRIKE PRICE PLUS PREMIUM.

Take a look at how Credit Suisse X Links Crude Oil Shares Covered Call ETN USOI (blue line) compares to a non-covered oil ETF (orange line). Remember, this chart doesn’t account for USOI’s fat dividends, but if you wanted to be long oil, you would have surely missed out!

XLYD, QYLD and RYLD ETFs Explained

The covered call ETF’s XLYD, QYLD, and RYLD (offered by Global X) all employ selling an at-the-money call representing 100% of their underlying portfolios. Respectively, they track the S&P 500, the Nasdaq 100, and the Russell 2000.

The closer your call is to being in-the-money, the more premium you will receive. It is because of this these three ETFs all have the highest dividends on our list.

But remember! When you sell at-the-money calls, you don’t participate in much price appreciation. And following a market crash, it may take a very long time indeed for your share price to play catch up.

For example, all markets crashed when the pandemic hit, but the Nasdaq soared on the tail of Covid. When you sell a covered call, however, your upside is limited to the premium received. This means that the QYLD fund participated very little in Nasdaq’s rally, as illustrated in the below 3-year chart comparing QYLD (purple) to its benchmark, the Nasdaq, as represented by QQQ (orange line).

The above chart represents the downside to covered call ETFs. There is, however, a pretty great upside. In an environment where the stock is stagnating, you’ll still be making a nice fat dividend. These three ETFs pay between 9 and 12% annually!

XLYG and QYLG ETFs Explained

XLYG and QYLG are two relatively new funds offered by Global X. Their representative indexes are the S&P 500 and the Nasdaq 100, respectively.

Similar to XLYD, QYLD, and RYLD, these funds sell one-month at-the-money calls on their indexes. However, there is one huge difference – XLYG and QYLG only sell these calls on 50% of their stock.

What does that mean? It means the other half of the equity is free to run higher (and lower) with the stock.

Since we are only selling calls on half of our positions here, it makes sense that the dividends for these two ETFs are lower.

GLDI ETF Explained

The GLDI ETF (offered by Credit Suisse X-Links) implements a covered call investment strategy in gold through the GLD ETF, which tracks the price of gold.

This fund offers investors who are neutral to minorly bearish in gold a great way to make a little extra income. I say minorly bullish because the fund sells calls that are 3% out-of-the-money on a monthly basis. This means the ETF can run 3% higher before we start missing out on price appreciation.

What is attractive here is the high dividend yield of 9.77%. Most of our other funds receive this kind of yield from selling at-the-money calls. But remember, gold is a lot more volatile than the S&P 500! The premium here is justified by the volatility in the underlying.

KNG ETF Explained

Last on our list is the KNG ETF, offered by First Trust. This fund tracks the S&P 500 Dividend Aristocrats Target Income Index.

Like XLYG and QYLG, this ETF is a hybrid fund. Here’s how First Trust describes its fund:

Perhaps most important is the low option exposure this ETF has: covered calls are written on a notional value of no more than 20% of the value of each underlying Aristocrat Stock.

This low covered call exposure is the reason for its relatively low dividend yield of 3.40%. This is a great ETF for minorly bullish investors on the S&P 500 Dividend Aristocrats Index.

Final Word

So what do we take away from all of this? ETFs are a great way for novice and advanced traders alike to participate in the covered call strategy. There are downsides as well as upsides. It is not free money; you are giving up A LOT when you decide to invest in a covered call ETF. Having a solid grasp of how options work is a prerequisite.

Check out some of our recommended reading if you’d like to learn more about options trading!

What are your thoughts on covered call ETFs? Are they worth it? Let me know in the box at the bottom of this page!

Additional Resources

3 Covered Call ETFs That Yield Between 10-12% – TheStreet

How Covered Call ETFs Can Help for Your Portfolio – ETFDB

Vanguard ETF Comparison

VTI vs VOO vs VGT: Comparing Benchmarks

VTI: CRSP US Total Market Index

VOO: S&P 500 Index Explained

VGT: MSCI US IMI IT 25/50 Index Explained

VTI vs VOO vs VGT

VTI vs VOO vs VGT: Comparing Fees

VTI vs VOO v VGT: Sector Diversification

VTI vs VOO vs VGT: Comparing Top Sectors

VTI vs VOO v VGT: Largest Stock Holdings

VTI vs VOO vs VGT: Top Stock Holdings

VTI vs VOO v VGT: Price Performance

Average Annual Performance- Quarter End

Final Word

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Source: ProShares.com

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