03. How ETFs are Used

How ETFs are used in Trading

ETFs make it easier to invest in commodities and international stocks.
ETFs are also used for hedging (we’ll see how a bit later).

Commodities are raw materials that are interchangeable and tradable. Commodities include energy, precious metals, and agriculture.

Commodity Futures

Futures contract are standardized agreements between two parties to trade an asset at a future date, at a predetermined price.
The participant who agrees to buy is “long” the future.
The participant who agrees to sell is “short” the future.

If you entered into a futures contract and wish to cancel, or “close” your position, you may do so by entering into an opposing position in the same asset, at the same due date.

Note that futures are a form of standardized “forward contract.” A forward contract is a specific agreement between two parties that isn’t standardized for other buyers or sellers. Since forward contracts are tailored specifically by the two counterparties, they’re not tradable like futures contracts. Forward contracts are also referred to as “bespoke”, which is just another word for “custom made” or “tailor made”.

Futures contracts have standard contract sizes, (also called “lot sizes”), and also standard due dates. An example of a standard contract size is the NYMEX Gold Futures, which has a contract size of 100 troy ounces. Since futures are standardized, they are tradable.

Commodity ETFs

Investors who wish to gain exposure to commodities may buy futures contracts, but this requires them to roll over their positions regularly. Rolling over a futures contracts involves closing out the existing position before its due date and then taking a new position that is due at a later date. Commodity ETFs handle this, so investors could more easily buy and hold shares in a commodity ETF and not worry about rolling over individual futures contracts.

International ETFs

If investors wish to trade international stocks, these stocks would be listed on a stock exchange of another country, and may be in a different time zone. This means that trading is done during the stock exchange’s open hours, which may not be as convenient for the investor. International ETFs are traded on a local stock exchange, while they are still linked to the stocks that are listed abroad (you’ll see how later in this lesson). So investors can trade international ETFs during the open hours of their local stock exchange.