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61 Cards in this Set

  • Front
  • Back
Option
Gives the holder the right to buy or sell a certain amount of an underlying asset (such as common stock) for a specified price over a specified amount of time. Puts and calls posses value to the extent that they allow the holder the right to benefit from price movements in the underlying asset
Put
Enables the holder to sell the underlying security at a specified price (exercise or strike price) over a set period of time
Call
Gives the holder the right to buy the security at the stated (strike) price within a certain time period.
Covered Position
You own the underlying position or have something to offset risk
Naked position
You do not own the underlying position
Strike price
Stated price at which you can buy a security with a call or sell a security with a put
Expiration date cycles
Three Cycles:
1) Jan/Apr/July/Oct
2) Feb/May/Aug/Nov
3) Mar/Jun/Sept/Dec

Usually last 3, 6, 9 months and they expire on the hird friday of the month of expirations
Expiration date
Stated date when option expires and becomes worthless if not exercised
In-the-money call
Stock price > strike price

(good!)
Out-of-the-money call
Stock price < strike price

(bad!)
Buying for speculation
*Don't own the security
*You buy this way when you think you know the direction of the price
Hedging
*Buying the option to protect current systems
Writing options
*When you write the put/call
Straddle (write)
You write a put and a call and you make money if price is stagnant
Straddle (buy)
You buy a put and a call and you make money as long as the price moves
Hedging with stock options
*The purpose is to reduce or eliminate risk
*Combines two or more securities into a single investment position
*Hedging a long position
-you own the position
-buying a pit while holding appreciated stock in the same company
-would provide insurance in case stock price foes down before you sold the stock
*Hedging a short position
-selling short and buying a call
-cover you if the price goes up
Writing Stock Options
*The seller/maker/writer is betting that the option buyer will be wrong about the direction of the stock price
*Statistically, the odds favor the writer
-easy money if the option expires "worthless"
-high risk if the option is "in-the-money"
>Naked option: no limit on loss of exposure
>Covered option: loss exposure is limited to original price paid for security
Equity Collars (why)
Collars are used mostly by investors who have accumulated a large positon in a given stock and who are primarily interested in protecting themselves against risk
Equity Collars
*Consists of simultaneous purchase of a put option and the writing of a call option
*Both options are out-of-the-money and have the same expiration date
Stock Index options
*A put or call option written on a specific stock market index
-S&P 500
-S&P 100
-DJIA
-NASDAQ 100
Options: Warrants
*Warrant: a long-lived option that gives the holder the right to buy stock in a company at a price specified on the warrant
*Specified on the warrant
-warrants have the longest lives of all types of options with maturities that extend out 5, 10, 20 years or even more
-warrants are created by the organizations that issue the underlying financial asset
-usually added as "sweeteners" to bond issues
-typically trader through brokers
Advantages of warrants
1) Offer a chance to benefit indirectly if the common stock price goes up without buying the stock
2) Low unit cost
3) Loss exposure is limited to price of warrant
Disadvantages of Warrants
1) Have no voting rights
2) Pay no dividends
3) Have no claims on assets of the issuing company
4) Eventually expire
Cash Market
A market where a product or commodity changes hands in exchange for a cash price paid when the transaction is completed
-takes place on location, not on an exchange
Futures Markets
The organized market for the trading of futures contracts
Futures Contract
A commitment to deliver a certain amount of some specified item at some specified date in the future at a negotiated price
Purpose of the futures market
*Price discovery
*Risk bearing/sharing
Futures Participants
*Speculators
-80-90% lose money
*Hedgers
-user
-producer
Futures Exchanges
*Chicago Board of Trade began in 1848
*US Commodities exhanges
-CBOT is the largest
-CME group; CBOT, CME, NYME
*US exchanges use some e-trading and "open-outcry" auction
-futures are mostly electronic
-options are mostly open outcry
*Serves as a way to provide credibility to the parties involved
Advantages of using futures contracts
*Potential for high return
*Margin buying allows use of leverage
-leverage: the ability to obtain a given equity position at a reduced capital investment, thereby magnifying total return
*Allows producers to hedge prices
-don't have to sell crops at harvest time when prices are often low
Disadvantages of using futures contracts
*High risk of losing more than amount originally invested; no limit on exposure to loss
Delivery
*99.2% of contracts are settled without actual delivery
Options (vs. futures contracts)
*Right to buy
*Strike price specified in option contract
*Loss limited to price paid for option
Futures contracts (vs. options)
*Obligation to buy
*Delivery price set by supply and demand
*No limit on potential loss
Trading Mechanics
*Bought and sold through brokerage offices
*Same types of orders are used as stocks
-market
-limit
*Long position; buying a contract
-investor wants contract price to go up
*Short position
-investor wants contract price to go down
*Long and short positions can be liquidated by executing an offsetting transaction
-about 1-4% of futures contracts are settled by delivery
Margin trading
*All futures contracts are trading on margin
*Initial margin deposit
-amount deposited with broker at the time of commodity transaction to cover any loss in market value of futures contracts due to price movements $10-20,000
Margin requirements = 2-10%
*Maintenance deposit
-Minimum amount of deposit required at all times
-Margin call occurs if value drops below allowed amount
-mark-to-the-market occurs daily
Factors in commodity price behavior
*weather and crop forecasts
*Economic factors
*Political factors
*International pressures
Commodity price behavior
*because of leverage, small unit price changes can cause large total dollar changes in contract price
*to protect investors, daily price changes limit are set
-daily price limit: restriction on the day to day change in price
-maximum daily price range: the amount a commodity price can change during the day; usually equal to twice the daily price limit
Financial Futures
*Future contract in which the commodity is a financial asset, such as debit securities, foreign currencies or market baskets of common stock
*Often used by large institutional investors to hedge
Types of Financial Futures
*Currency futures
-US dollar
-Japanese Yen
-British pound
*Interest rate futures
-US treasury bills
-notes
-bonds
-foreign gov't bonds
*Stock Index Futures
-DJIA
-S&P 500
-Nasdaq
Speculating with Financial Futures
*Leverage provides high returns/losses
*"long" used when prices are expected to rise
*"short" used when prices are expected to fall
(during an unstable market)
Hedging with financial features
*Effective way of protecting stock or other securities holdings in a declining market
*Stock index futures to hedge stock portfolio
*Interest Rate futures to hedge bond portfolios
*Foreign currency to hedge foreign exchange rate risk
IRS Tax Rules
*Publication 550
*Income reported on various schedules
*Investment expenses on miscellaneous expenses on schedule
Holding Periods
*Assets held </= 1 year are taxed as ordinary income (0-39.6%)
*Assets held > 1 year are taxed at capital gains rates of 0%, 15%, 20%
*High income earners (200,000-250,000) also pay 3.8% net investment income tax
Reporting Losses (the good news)
*Can be used to offset gains
*Losses of up to $3000 can be used to reduce ordinary income
*Losses over $3000 can be carried over
Reporting Losses (the bad news)
*Losses from a wash sale are not permitted
*Wash Sale: the sale and repurchase of a stock within 30 days
*While the loss is not tax deductible it can be added to the basis on the new purchase
Tax strategies-Avoidance or transfer
*Distribute Assets to family members
-during life-to a lower tax bracket
-through your estate for a stepped up basis
-create a trust to use your personal gift exemption
-charitable gifts of appreciated assets
Deferral Strategies
*Favoring growth stocks
*401K
*IRA
*Roth IRA (never have to pay taxes)
*Annuities
Tax Favored Strategies
*Qualified dividends instead of interest-taxed at 0-20%
*Gov't/Municipal Bonds
*Selling a personal residence
Penny Stocks
*Trade at or under $5
*Less than 4 million in net tangible assets
*Some are "legit"
*Shell companies
Pricing
*Quoted on "pink sheets"
*Bid/Ask
*High Spreads
-more than other stocks
-sometimes 25-33%
-maybe 50-100%
*Mark ups
Trading
*OTC bulletin board
*Pink sheets
*Sellers are often market makers
Risks
*Heavily promoted but thinly traded
*Manipulation
*High pressure sales
*Unscrupulous
*Unauthorized transactions
*Lack of "due diligence"
Why Real Estate? Pro
*A hedge against inflation
*Leverage enhances your returns
*RE will increase because they're not making more land
*RE is safer than the stock market
*A man's property is his castle
*RE is a tax shelter
Why Real Estate? Con
*Inflation increases IR and other casts (taxes, etc)
*Leverage makes you a slave
*There is a lot of vacant land in the US
*RE value is hard to determine, it lacks utility
*Building codes control you
*Tax laws change and that can hurt you
Key Factors of Real Estate
*Location, Location, Location***
*Timing
Real Estate Alternatives
*Land use determines value
-Farm
-Recreational Area
-Single family homes
-Industrial
-Apartments
-Commercial
Real Estate Alternatives
*Single family residence
*Apartments
*Commercial (retail rentals and office space)
*REIT (real estate investment trusts)
-equity
-mortgage
-hybrids
Assessing the Risk
*Community
-growing or stable
*Neighborhood
-vacant shops
-homes for sale
*Immediate surroundings
-condition of buildings
-safety
*Financial standards
-occupy rate, operating expenses
REIT types
*Equity
*Mortgage
*Hybrid
Evaluation
*degree of diversification
*amount of debt
*experience of management
*does management have ownership stake
*income and cash flow