This post is an extension of Mutual funds that use covered call strategy that was published on Dec 2, 2008. Here are some more mutual funds that use covered call strategy apart from EROAX that was discussed earlier.

Goldman Sachs U.S. Equity Dividend and Premium Fund (GSPAX) uses covered call strategy to outperform S&P 500. This fund writes calls that cover from 15% to 35% of the portfolio. This fund writes covered calls mainly on S&P500 index options.

Eaton Vance Tax-Managed Buy-Write Income (ETB) is a closed-end fund that also uses covered call strategy. Its stock portfolio roughly tracks S&P 500 and writes covered calls on S&P500 index call options.

The idea behind covered call mutual funds is that portfolio can be hedged against the market swings using the covered call options. If the stocks go up, the stock portfolio’s gain will be up. If the stocks go down, the stock portfolio’s loss will be offset by gains in the covered calls.

However, this strategy can help only to some extent. Gains from covered call options are limited. If the stock’s price goes down dramatically, covered call options can’t completely offset the stock loss. In this case, stock portfolio would suffer serious losses. Covered call strategy would work for mutual funds only if the stock portfolio doesn’t suffer from violent swings. This is why most of the covered call mutual fund managers structure their stock portfolio to imitate S&P 500.

Disclosure: I do not own the mutual funds mentioned in this post.

Related Link: Mutual funds that use covered call strategy

What will you do if you know the stock you own is “fairly valued”? Sell! That’s what Meredith Whitney, bank analyst, recommended.

I owned Goldman Sachs (GS) shares and I still have some stock options on Goldman Sachs. I was planning to unload them just before Goldman Sachs’s earning announcement on October 15th. I am late by two days, Meredith slapped “neutral” rating on Goldman Sachs today and the stock fell by 2% to $186. I sold all my shares this morning and put tight stop in option positions.

Meredith Whitney said she now believes bank stocks are “at least fairly valued.” and downgraded Goldman Sachs from “buy” to “neutral”. Neutral is the nice way of saying “Sell” in Wall Street.

Ms. Whitney, whose bearish calls on large bank stocks gained renown during the financial crisis that erupted last year, said in a note she is now “far less bullish” on banks than last quarter and urged clients “either to take profits or go neutral into the next two weeks.” She also lowered her earnings outlooks for Bank of America (BAC) and Citigroup (C). Panic set in now. Even the banking stocks like J. P. Morgan Chase (JPM) fell 1.8%.

If you own banking stocks and had decent profits in the recent run, you may want to unwind some positions to protect your profit. Major U.S. banks report earnings this week starting with J.P. Morgan Chase tomorrow. Goldman Sachs and Citigroup report on October 15th. Bank of America will announce earnings on October 16th.

Take your profits when you can!

Related Links: Goldman Sachs Downgrade | Caution: Banking Stocks Ahead

Disclaimer: I own stock options in Goldman Sachs.

Rambus (RMBS) is going to report earnings on October 15th. It appears that some people already know Rambus is going to report good earnings. May be some serious speculation is going on. Rambus is up $1.07 (6%) today. There is a lot of action going on in Rambus’s call options. As I write this, more than 9,454 call option transactions for October 18 call took place today. Someone is expecting huge move after Rambus reports earnings next week. October calls expire on October 16, one day after Rambus reports earnings.

Rambus’s options volume is running six times the usual volume and call volume accounts for 88 percent of today’s volume.

Options activity in XTO Energy (XTO) also rose to two times the usual volume, with 34,000 traded and put volume representing about 69 percent of the activity. XTO Energy reports earnings on November 4th. KB Homes (KBH) also experience similar options activity that is running two times the usual volume. 19,000 contracts traded and put volume accounting for about 86 percent of the activity.

Disclaimer: I do not own stocks or options mentioned in this article.

Chicago Board Options Exchange’s volatility index (VIX) jumped to its highest level yesterday since Sept. 3 as stocks slipped lower for the third day in a row. I love higher VIX, that’s when my option trades are more profitable. This may not be the appropriate statement given the current market condition! But, that’s the fact. I buy stocks and sell options when the VIX hits high. When everyone is panicked that’s when you should go for your favorite stocks and options. VIX is around 28.22, well above the recent trend.

Numbers from Institute for Supply Management (ISM) yesterday spooked many investors and caused huge drop in all indexes. ISM , a group of purchasing managers, reported that its index of manufacturing activity was at 52.6 in September, down from 52.9 a month earlier but still reflecting an expansion for the second consecutive month. Any reading above 50 indicates growth in manufacturing activity; below 50 is contraction. We are still in growth mode, not as much growth as you would expect, but still the manufacturing industry is picking up strength.

On the other side, today’s employment numbers are bad. This is going to be bad for many more months to come until businesses gain confidence. I am not going to turn negative on the market because of these numbers. I personally know how hard to hire right people at this time. Unemployment situation will turn around, not sure when. I am continuing to buy good stocks at better prices. More fear in the market is good for prudent investors.

Related Link: Fear Factor

Trading in the stock options market can be a very lucrative way to make a living, but it is also a place where many people lose their hard earned money very quickly. What exactly is an option? An option is defined as a contract that gives the buyer the right to buy an underlying asset at a specific price or before a certain date. The buyer has the right, but has no obligation. There are two types of options, calls and puts. Calls give the holder the option to buy a stock at a certain price within a specific period of time. Puts give the holder the right to sell an asset at a certain price within a specific period of time. Put more simply, if someone buys a call they are hoping the stock price will increase substantially before the option expires. If someone buys a put they are betting that the stock price will go down substantially before expiration. Options are derivatives because they derive their value from an underlying asset, the main company stock.

What kind of benefits does options trading have? Trading derivatives and options gives you a great amount of flexibility and the ability to hedge your bets more than just a common stock does. What downfalls do options have? Options are extremely speculative and are far more risky than a normal common stock. In many cases if the common stock moves in the opposite direction you are hoping for it to move, your option may be worth virtually nothing when the expiration date comes.

The bottom line is that the everyday consumer has no business being in options trading. Options trading is only for those professionals who have mastered the market to a point that they can feel comfortable taking on so much risk. For everyday individuals such as you and I, options involve far too much risk and are not a good way to invest your hard earned money.

When you see a panicked market, how do you measure the fear? VIX helps you to do just that. CBOE introduced Volatility Index (VIX) in 1993. It is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX indicates how fearful and volatile the stock market is.

VIX provides minute-by-minute snapshot of expected stock market volatility over the next 30 calendar days. VIX is calculated from the prices of S&P 500 options for various strike prices. More details and sample calculations are here.

VIX reached the record close of 80.86 in November 2008 at the height of economic crisis. It’s now close to 43. Not long ago, anything above 30 indicated high level of fear. VIX hasn’t closed below 30 in the last four months. Understanding of VIX would help you to gauge the market fear and take the appropriate investment decisions.

When the VIX is high, the stock options are priced higher. For example, if the VIX is at 25, Google March 300 calls may be priced at $23. Right now, Google March 300 calls are trading at $37.50 with the VIX at 43. This is a simplistic example – in reality, the option pricing is also depending on stock’s implied volatility. If you are an option seller, higher VIX would help you make more money. If you own stocks and want to write covered calls on the stocks, higher VIX would fetch you higher option premium. On the other hand, if you want to buy puts to protect your stocks, higher VIX would make you to pay more for put option premium.

When the VIX climbs higher, the general sentiment is that market is reaching the bottom. Traders used to believe that with all the fear in the market, there would be some kind of capitulation. That theory was proved wrong in the last few months. VIX keeps climbing higher; there is no sign of capitulation.

VIX is the good indicator to see the market trend. I personally use VIX to decide whether to sell options. Higher VIX inflates the option premiums and provide a good opportunity to sell put or call options.

CBOE introduced VIX options in February 2006. You can bet on VIX direction and buy/sell options on VIX. You can also use VIX options to hedge your investments against any future volatility. Stock options expire on third Friday of each month. However, VIX options expire on third Wednesday of each month.

If you are anxious about when the stock market carnage would end, keep watching VIX – the fear factor.

Related Links: VIX options guide | Economy in free fall

Most of the mutual funds go long (buy and hold) on the stocks. Some of them short the stocks. Few mutual funds practice long-short strategy meaning that they go long some stocks in their portfolio and short the rest of the stocks.

Traditionally, mutual funds used to buy or short the stocks. They don’t normally play with options. Derivatives like options are the favorite of hedge funds. Mutual funds tend to stay away from the derivatives to reduce the volatility. However, in the recent years some mutual funds were started to adapt the “buy-write” strategy which essentially is writing covered calls on the stocks owned.

What is covered call? If you own a stock, you can write a call option on that stock. You already own the stock, so it is “covered call”. If you write a call option on a stock without owning the stock, it’s called “uncovered call” or “naked call”. Ok, don’t ask me why it’s called naked!. May be because some people lost their cloths by writing uncovered calls.  Covered calls are conservative play. Uncovered calls are dangerous, there is literally no limit for the loss if uncovered call option position goes against you.

When you write a call option on a stock, you promise the buyer to deliver the stock at a certain price on or before a specified date. You get the call option premium from the option’s buyer to reward you for your commitment. The buyer wants to buy your call option, because he/she thinks that stock will go up soon. If the stock goes up after you write the covered call you will lose all the upside potential of the stock. If the stock goes down, the buyer of the call option lose the money.

In difficult times like the one we currently face, writing covered calls on the stocks you already own would be a prudent thing to do. Covered calls are also known as “buy-write”. Some mutual funds offer funds that use covered call strategy to reduce the volatility of the portfolio. Risk managed equity option income fund (EROAX) from Eaton Vance is one of them. This fund seems to weather the storm of the recent weeks compared to S&P 500. See the chart below for the comparison.

Disclosure: I do not own the mutual funds mentioned in this post.

If you like this post, check out the part-2 of this post.

I have never seen a stock brokerage company that offers discount in commission on the eve of Thanksgiving day! Folks at OptionsXpress offers 50% off commission on all sell orders on Friday, November 28th.

This offer is available only for sell orders, not for buy orders. I don’t think it’s a wise thing to sell the stocks/options just to gain $7. If you really want to get rid of something in your portfolio and your account is with optionsxpress, this may be a good idea. Personally, I think the time is ripe to buy good stocks. I won’t sell anything now.