Do you have questions about stock and option trading? We answer your
What is your opinion on writing covered calls on more volatile stocks?
Written by Clara, Newport Beach, CA
All trading strategies have pros and cons. Writing calls on high
implied volatility stocks is a riskier version of the traditional covered call
strategy. A common misunderstanding of implied volatility is to interpret it as
a directional indicator, i.e., to conclude that Google’s high implied
volatility means traders are expecting Google’s stock price to rise. High
implied volatility communicates a consensus in the market that the underlying
stock price will likely make a larger move that it has in the past – but it
says nothing about the direction of that move.
Therefore, writing calls on high implied volatility stocks can be
expected to result in a wide range of results. If the stock price plummets, we
may have received a rich premium for the call, but it will not be sufficient to
cover all of the losses; if the stock price makes a stellar rise, the stock
will be called away and the position will be profitable, but the person simply
holding the stock position will have made a larger profit. In general, the
results from this strategy will be more volatile than the usual ATM or slightly
OTM covered call strategy with more conservative blue chip stocks.
What is the "fair value" I see on CNBC in the morning?
Written by Duane
Fair value is, in essence, the market price of the basket of stocks under consideration. For example, the fair value for the S&P 500 that you see quoted every morning consists of the market price of all 500 stocks that make up the S&P 500, adjusted for the opportunity cost (interest on the purchase cost) and dividends received. This number is compared to the price of the S&P futures contracts. So if the futures are trading higher than fair value before the stock market opens, you might expect the S&P 500 to trade higher at the open. CNBC publishes the Dow, Nasdaq and S&P futures compared to their fair values to give investors an idea of what to expect in the upcoming trading day. Of course, the market's trading direction can change quickly after the market opens.
"I use diagonal spreads to generate income. How should I protect my downside?"
Written by Anton
Placing stop losses on your trades is essential to your success. But where you place that stop loss trigger is largely a personal style issue. When I use covered calls, I place my stop loss contingency order about 7-8% below the stock purchase price. This will normally hold one's loss to within 5-6%. With a diagonal spread, the long call is your surrogate for the stock position, but with less capital at risk. If you use an 8% stop loss based upon the stock price, that will correspond to a much larger loss on your diagonal spread, probably of the order of 50%. However, that is typical of options trading - the leverage works both ways. If you try to place a tighter stop loss, the probability of being whipsawed out of the trade increases, i.e., intraday price movement trips your contingency order and then the stock trades back up. In any case, be sure you have learned how to place OTO (One Triggers the Other) contingency orders with your broker. In these orders, you select a stock price as the trigger for an order to buy to close the short call; that order's execution triggers a second order to sell to close the long call. Contingency orders help us maintain good trading discipline.
"What is the difference between an Iron Butterfly and an Iron Condor?"
Written by Chris, Denver, CO
Iron butterfly and iron condor spreads are actually at extreme ends of the same position. You form an iron butterfly by selling a call spread and selling a put spread where the short strikes are at the same price. The iron condor is also formed by selling a call spread and a put spread, but both spreads are far OTM (out of the money). If I pull the short strikes of my iron butterfly apart by $10 or $20, some would say this is now a condor. I still call it a butterfly, but that is just a semantics argument. I refer to positions as iron condors where the spreads are far OTM, whereas a position where the short strikes are "closer to the fire", I would consider to be an iron butterfly, even if the short strikes are not at the same price.
"I have heard of people trading the “Qs”. What are these things?"
Written by Sam, Yorkville, IL
The Qs are an ETF made up of the 100 largest NASDAQ stocks (ticker symbol = QQQQ). In general, SPY is a more broadly diversified ETF whereas QQQQ is largely high tech stocks. Consequently, QQQQ tends to rise faster in bull markets but also fall faster in bear markets.
"Is “selling naked puts” dangerous?"
Written by Brad, Aurora, IL
Yes and no. You can create a position by selling put options in such a way as to be exposed to large losses if the stock declines suddenly. However, it is possible to sell puts to either generate monthly income or to build a stock position in your portfolio at a discounted price; and this can be done safely with the use of contingency orders placed with your broker.
"What are Bollinger Bands?"
Written by Ray, Seattle, WA
Bollinger bands are lines drawn on a stock chart at plus or minus two standard deviations from the stock price. The theory is that when a stock price is near the upper range of the bands, it is more likely to move down rather than upward, and vice versa. Bollinger Bands are one of the more common technical indicators used to evaluate stock price movements on a chart.
"I've heard that trading options is risky and akin to gambling."
Written by Jay, Washington, D.C.
Options can be used in very conservative ways to protect or "insure" your stock portfolio. They can also be used in conservative strategies to generate a steady monthly income. But options can also be used for highly leveraged speculation on the movement of particular stocks or the entire market. People have gained and lost large amounts of money speculating with options. Dr. Duke teaches you how to use options in very conservative ways.
"What are ETFs?"
Written by David, Edmonton, Alberta, Canada
ETFs, or exchange traded funds are essentially trusts made up of the stocks representing that industry sector, e.g. the SPDRs (pronounced, “spiders”, ticker symbol SPY) are made up of the Standard and Poors 500 stocks. ETFs are superior to mutual funds in several respects; ETFs have less overhead expense (less than 0.5% compared to mutual fund fees as high as 5%); you can buy and sell ETFs anytime the market is open for the standard stock trading commission; the ETF holder does not incur capital or short term gains unless he decides to sell the ETF; you can use options to protect or augment the gains on ETFs.
"Are covered calls suitable for this volatile market?"
Written by Renee, Los Altos, CA
In general, the covered call strategy requires the underlying stock to either increase in value or trade sideways. Since most stocks have been steadily declining recently, this may be a difficult criterion to meet in this market. However, if you did find a suitable candidate, the advantage of this volatile market is that the premiums of the call options are quite high and this increases the returns of this strategy.
I have been exposed to several other trading services and I
think you are the most honest one by far. The other ones I always got
the impression I was being given ideas from people that were generating
them only to have a trading service and that they make their money on
the service fees only and don't actually trade. I feel like you do
actually trade your trades and from watching Time and Sales on TradeStation,
which also provides historical data, I believe I have confirmed that. I
do not mean to offend, but in this world you never know who can you
trust. For further proof, I was pleased to see in your blog last night
that you said you did not get filled on your Oct call spread, which I
could see that you had not been, unless you had paid up big time from where you entered the order.
Also, your Thursday night meetings are quite good. I have attended other similar
meetings and despite being completely enthralled with the market found
them to be quite boring and basically no more informative than what I
could have done. Yours seem to fly by and I felt like I was actually
getting something I could use.