Advanced ETF Strategies
The unique structure of exchange-traded funds makes sophisticated investment techniques possible.
Core/Satellite
This strategy is a blend of index and active investing. Index investments, such as ETFs become the foundation of the portfolio's construction and actively managed investments are added as satellite positions. With this approach, investors index their core holdings to more efficient asset classes and limit their selection to active managers that deliver consistent alpha or outperformance for other categories. Today, most large pension plans use a core/satellite approach in their investment policy and many investors are beginning to do the same.
Hedging
ETFs are effective hedging tools for managing risk. For example, investors can guard against over concentrated equity positions by using ETFs as single stock substitutes. This hedging technique can reduce risk and volatility by letting stockholders diversify away from large equity positions to the companies they own or work at.
Leverage
Like individual stocks, ETFs can be leveraged with margin. Margin is borrowing money from a broker to buy securities and involves considerable risk. Minimum maintenance requirements are enforced by the NASD (National Association of Securities Dealers), the NYSE and by individual brokerage firms. While margin investing can be profitable for investors correct about the direction of their holdings, the interest charges or borrowing costs can deteriorate returns.
Options
ETF investors have a multiplicity of option strategies at their disposal. Purchasing call or put options is an aggressive technique. An options investor can control a large amount of ETF shares by paying a premium. The premium price is a fraction of what it would cost to purchase the shares in the open market. This provides an options investor with a great deal of leverage and a high risk/reward opportunity.
A more defensive approach uses put options in conjunction with portfolio holdings. Buying protective puts on ETF positions would insure a portfolio against declining prices. There are many other tactical possibilities with options.
Shorting
ETFs, like individual stocks, can be shorted. Shorting involves selling borrowed shares an investor does not own in expectation the price of an ETF will decline in value. If the ETF does decrease in value, it can be bought by the short seller at a lower price, which results in a profit. Shorting individual stocks on a downtick is prohibited, whereas ETFs are exempt from this rule. This translates into easier and fluid short selling with ETFs.
Shorting is an advanced technique and involves substantial risk.
Sector Rotation
Convenient market exposure to various industry sectors is readily obtained with ETFs. By tactically shifting assets, investors can over and underweight specific sectors according to their financial research, economic outlook, or market objective. Owning or selling concentrated business segments allows ETF investors to capitalize on both positive and negative sector trends.
Tax Loss Harvesting
Wash-sale rules don't permit investors to realize a stock loss if they repurchase the same stock within 30 days. This problem can be avoided with smart tax loss planning. By redeploying the loss proceeds into an ETF in the same sector as the stock, for example, the wash-sale rule can be avoided. This allows investors to offset any capital gains with capital losses and still maintain market exposure.
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Any specific securities, or types of securities, used as examples are for demonstration purposes only. No information on this Web site should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security.
Investors should consider the investment objectives, risks, charges, and expenses of an ETF carefully before investing. For a prospectus containing this, and other important information, contact the fund company. The prospectus should be read carefully before investing.
Investors should consider the investment objectives, risks, and charges and expenses of a mutual fund carefully before investing. A mutual fund's prospectus contains this and other information about the mutual fund. Prospectuses are available through our trading site or through a Scottrade branch office. The prospectus should be read carefully before investing. No transaction fee (NTF) funds are subject to the terms and conditions of the NTF funds program. Scottrade is compensated by the funds participating in the NTF program through recordkeeping, shareholder, or SEC 12b-1 fees.
Investors should consider the investment objectives, risks, charges, and expenses of an Exchange-Traded Fund (ETF) carefully before investing. A prospectus contains this and other information about the ETF can be obtained from the issuer. The prospectus should be read carefully before investing.
Margin trading involves interest charges and risks, including the potential to lose more than deposited, or the need to deposit additional collateral in a falling market. Margin Disclosure Statement and Agreement (PDF) is available for download, or it is available at one of our branch offices. It contains information on our lending policies, interest charges, and the risks associated with margin accounts.
Options are not appropriate for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (also available at one of our branch offices). All option accounts require prior approval by Scottrade.
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