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110 Cards in this Set
- Front
- Back
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Options Basics
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2 party Contract
--Zero Sum Game Buyer Seller Holder Writer Owner Long Short Pays Premium Receives Pr Has Rights h Obligation Wants 2 Exercise 2 Expire |
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Option Terms
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Buy 1 DEF APR 60 call @ 7
Action: buy or sell # of contracts: 100 shares per contract Underlying Security Expiration month Strike Price per share Type of option= put or call Premium per share You have right to buy 100 shares of DEF stock at $60. you paid $7 per share and right expires in April |
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Long Call
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Right to Buy= Bullish
Buy 1 ABC OCT 40 call @ 6 Max Gain: unlimited Max Loss: Premium($600) Break Even: SP + Premium T chart to figure out gain or loss: Out In -6 42 -40 CMV goes to 42 end up with $400 loss |
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Short Call
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Obligation to Sell= Bearish
Sell 1 ABC DEC 50 call @ 5 Max Gain: Premium (500) Max Loss: Unlimited Break EvenL SP+ Prem Out In 40 5 50 gain or loss? CMV at 40, 500 net gain |
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Long Put
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Buy 1 XYZ NOV 30 put @ 3
Right to sell= Bearish Max Gain: SP- Premium($2700 or 27 per share, all the way to zero) Max Loss: Premium(300) Break Even: SP- Prem Out In -3 30 Price needs to go to 27 to break even CMV goes to 32, net loss of $300 |
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Short Put
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Sell 1 DVP May 70 put @ 4
Obligation to Buy= Bullish Max Gain: Premium(400) Max Loss: SP-Prem(6600) Break Even: SP-Prem(price at 66) Out In -70 4 68 CMV goes to 68 net gain of 200 |
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Options Summary
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Long Short
Call Right to Obligation to Buy ^ v Sell Put Right to Obligation to Sell v ^ Buy |
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Option Generalizations
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With any LONG strategy the max loss is the premium
With any SHORT strategy the max gain is the premium With all call options breakeven is the strike price + premium With all put options the breakeven is the strike price - premium |
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In the Money
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if an option can be exercised its said to be "in the money" aka it has intrinsic value
To find the intrinsic value of a call= MV-SP Intrinsic Value of a put= SP-MV (remember CSX) If the call or put has no intrinsic value, it is "out of the money" If the intrinsic value is zero, the call or put is "at the money" |
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Intrinsic Value
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Premium= Intrinsic Value + Time
Find Excess premiums like you know how to do For these At expiration a short call has a premium of 3 1/2 IV= 3 1/2 TV= 0 --- because at expiration no time value left Short XYZ Feb 40 put @ cmv42 IV=0 TV= 2 |
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Options "One Liner"
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there are 3 things that can happen to an option contract
-- exercise -- expire -- close: fancy for trading the contract Closing the position means "do the opposite" -- if you by an option its an opening buy, to no longer have the position you must effect a closing sale Regular way settlement for option contract is T+1 Options expire in cycles -- max life span of a standard equity option is 9 months Max life span of a LEAP(long term equity option) is 39 months Options expire on the saturday following the 3rd friday of the expiration month at 11:59 pm est |
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Multiple Option Strategies
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Straddle- long & short
Spread- call & put Hedges- Full & partial |
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Long Straddle
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2 break even points
Remember to add premiums One foot in a call and one in a put Buy call and a put Max Gain: Unlimited Max Loss: Both Premiums When do you want a straddle: In times of high volatility, we just need it to move big in any direction Break Even(Call)= SP+ Prem Break Even(Put)= SP- Prem Buy 1 ABC Mar 80 Call @4 Buy 1 ABc Mar 80 Put @4 Break Even=88 Break Even= 72 We make money if the stock price goes out side that range, above 88 or below 72 |
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Short Straddle
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Max Gain= both premiums
Max Loss= unlimited Suggested in times of low volatility(stability) Best that can happen is if price stays around the same price Break Even(call)= SP+ Prem Break Even(Put)= SP- Prem Sell 1 XYZ Jun 70 call @2 Write 1 XYZ Jun 70 put @2 we make money if stock price stays between break evens Break Evens 74 and 66 so below 74 and above 66 |
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Spreads(rules)
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buy and sell a put
buy and sell a call --pay more in premium than received= net debit spread --receive more premium than paid= net credit spread -- different strike prices= vertical spread -- different expiration months= horizontal spread(time or calendar spreads) -- different strike price+ expiration months= diagonal spread -- if long option has the lower strike price= bullish -- if short option has lower strike price=bearish |
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Call Spread
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Buy 1 DEF Nov 75 call @7
Buy 1 DEF Nov 65 call @9 - call or put spread?(call) - vertical or horiz diag( same month, dif strike= vertical or price spread - net debit or net credit?=more in than out so net credit - bullish or bearish= look at long option and if long lower price, if no than we are bearish because short option has lower strike price net credit, vertical call spread that is bearish Break Even on Spread(CAL) (call add the lower) = add lower strike price to net premium 65+2= break even of 67 |
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Put Spreads
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Long 1 TRF Aug 40 put @5
Short 1 TRF Sept 30 put @2 vert, hori, diag= different months, different strike= diagonal spread net debit or credit= 5 out 2 in net debit of 3 bull or bear= look at option with lower strike price, not long lower stike price so i am bearish net debit, diagonal put spread that is bearish Break Even= PSH( put subtract net premium from higher strike price) 40-3= 37 break even |
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Widen or Narrow Spread
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Debit Narrow
Widen Credit number of letter need to match when we want to widen we want to exercise narrow want to expire to collect premiums |
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Assigning Premiums to Spreads
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Rules:
-- calls with lower strike prices have higher premiums -- Puts with higher strike prices have higher premiums Example: Long 1 CDC Feb 60 call@ Short 1 CDC Mar 70 call@ 60 call has to have higher premium than 70 call give 60 7 and 50 5 premiums so we have a net debit, -- bullish spread, bought call with lower spread with arbitrary premiums you can figure out net debit/credit, bull or bear, or widen/narrow |
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Hedging
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matching stock position with option contract
Full Hedge= buy the option= Protection Partial Hedge= Sell option= Income -- full hedge is buying option, protect position -- partial hedge= protect by selling option, for income |
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Long Stock Hedges(Full)
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Full Hedge= Protection
Position: Long 100 JPB @88 Option: Buy 1 JPB Feb 90 put @5 Max Gain: Unlimited Think stock is going to go down, to protect against a loss is with an option contract -- long stock hedge we want stock to go up and we want option to expire Max Loss: Stock+ Prem-SP Out In -88 90 -5 max loss of 3 per share or 300 Break Even: Stock+Prem=93 |
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Long Stock Hedges(Partial) (covered call)
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Partial Hedge= Income
--Generate income off a positon that isnt moving anywhere Position: Long 100 ABC @40 Option: Short 1 ABC Oct 50 call @5 Max Gain= SP+Prem-Stock 55-40=15 Out In 40 5 50 Max Loss: Stock-Prem 40-5=35/share Break Even: Stock-Prem 40-5=35 |
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Short Stock Hedges(full)
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Full Hedge= Protection
--think price might go up, need to protect against that, long call gives us option to buy closing out short position if stock price goes up Position:Short 100 PAF @38 Option:Buy 1 PAf Nov 40 call @3 Max Gain: Stock-Prem 38-3=35/share Max Loss: SP+Prem-Stock 40+3-38=5/share or 500 total Break Even: Stock-Prem 38-3=35 |
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Short Stock Hedges(Partial)
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Partial Hedge= Income
Short postion thats not moving, write put to give us obligation to buy, we want price to go down but not too much Position:Short 100 GTS @38 Option:Write 1 GTS APR 30 put @2 Max Gain:Stock+Prem-SP 38+2-30=10/share Max Loss: Unlimited Break Even:Stock+Prem 38+2=40/share |
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Hedging tips
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long stock+ long put= full hedge, most protection
Short Stock+long call= full hedge, most protection Long Stock+Short Call= partial hedge+income Short Stock+Short Put= partial hedge+income |
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Option Compliance
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All options and their performance are gauranteed by the OCC(option clearing corporation)
All new option accounte must be approved by the registered secuities futures and option principal prior to first option trade Option investor needs to sign and return option agreement within 15 days, no new option positions may be opened Positions limits are in effect for options on stocks, indexes, and currencies to prevent investors and groups of investors from manipulating markets |
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Option Expiration and Exercise
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American style may be exercised anytime during the life of the contract
European Style may only be exercised at expiration Options that are in the money by at least 1 cent at expiration will auto be exercised for the accounts of firms and customers If an investor exercises their option the OCC will assign an exercise notice to a broker dealer who is short on that option The broker dealer must then assign the exercise notice to a customer who is short the option based upon a "fair method"(random, fifo etc) of assignment |
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Option Contract Adjustment
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If underlying stocks splits its shares there must be a corresponding adjustment to all outstanding options contracts
Aggregate exercise price of the contract will remain unchanged 1 XYZ 50 call 100 shares, total value of 5,000 -- shares can change, value cannot if 2:1 split than: -- 2*1 = 2 -- 50/2=25 resulting option= 2 XYZ 25 call if 5:4 split -- 100*(5/4)= 125(shares) -- 50*(4/5)= 40 resulting option= 1 XYZ 40 call -- 125 shares -- value = 5,000(same) if 3:2 split -- 100*(3/2)= 150(shares) -- 50*(2/3)= 33.33 resulting option= 1 XYZ 33.33 call -- 150 shares, value still 5,000 |
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Index Options
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Two types of Indexes
-- broad based indexes like S&P 500, S&P 100 OEX -- Narrow based indexes like semiconductor index SOX, that track a specific industry Index options settle in CASH, investors account will be credited the in the money amount at the time of exercise or expiration -- investor account credited amount option in the money, but that isnt profit, profit is amount in money- premium paid for option |
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Currency Options
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value of one currency relative to another constantly fluctuates.
--U.S. dollar is benchmark against which the value of all other currencies is measured No options trade in the U.S. and the U.S. Dollar All Foreign Currency option contracts are for 10,000 units of the foreign currency ---Except for the Japanese yen, which is 100,000 units To calculate premium -- multiply quoted premium by .01 -- if options is for Japanese Yen, multiply the quoted premium by .0001 |
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Currency Options( what positions to take in what conditions)
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Remember EPIC(americans)
-- Exporters buy Puts -- Importers buy Calls Investor would buy calls or sell puts IF: -- good economic news from that country -- stock market rises in that country -- large discovery of oil, gold in that country -- government instability subsides Investor would but puts and sell calls IF: -- bad economic news from that country -- stock market in that country falls -- there is an increase in political instability |
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Interest Rate Options
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Investors can use interest rate options to
--speculate on the direction of interest rates --hedge a portfolio of Treasury securities Investors can establish a position in either price based options or rate based options Price Based Options: --options on a specific Treasury note or bond with $100,000 par or $1,000,000 par Treasury bill Rate Based Options --Options on the actual interest rate attached to the most recenty issued treasury bills, notes, bonds Price based options settle with the delivery of the underlying instrument Rate based options settle in CASH |
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Issuing Municipal Bonds
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munis are exempt securities
-- securities exempt from the act of 1933 -- no SEC registration neccessary |
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Process of Municial Bonds(7)
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1) Bond resolution & Preliminary Legal Opinion
-- the issuer decides to raise money, and authorizes the sale of its bonds by creating a bond resolution -- issuer then hires a bond counsel to render preliminary legal opinion -----unqualified legal opinion, meaning opinion wihtout conditions or restrictions -- issuer will decide: ---- firm or best efforts commitment 2) Hire an Underwriter -- underwriter responsible for offering the issuers bonds to the public Negotiated Bidding and Competitive Bidding -- Negotiated bidding: ----issuer chooses the underwriter ---- used with revenue bonds --Competitive Bidding ---- lowest cost to the issuer wins ---- used with G.O. bonds In competitive bidding process, issuer prints and Official Notice of Sale in the Daily Bond Buyer -- it includes all the details neccessary for the underwriters to submit their bid 3) Bond Indenture -- the bond indenture is a contract between the issuer and the underwriter they've chosen -- spells out the terms and conditions, andis binding on both parties 4) Creating a Syndicate The main reason to form syndicate is to spread the risk among underwriters (2 or more B/Ds join together to underwrite and spread risk) Classifications: -- managing underwriter= Lead Underwriter, Underwriter hired by issuer ---- has most risk ---- earns the spread -- Syndicate Member ---- firm that joins with the syndicate manager to sell the issuers bonds ---- has risk if all the bonds arent sold ---- earns the total takedown -- Selling Group= firm that sells the issuers bonds ---- no risk if bonds arent sold ---- earns the selling concession 5) Determining Underwriters Compensation Risk=Reward -- Ex: 990= Proceeds to Issuer 1.25= Managers Fee 3.75= Additional Takedown 5.00= Selling Concession 1000 POP --Additional Takedown + Selling Concessions= Total Takedown --- this is the amount earned by syndicate members ---- they have to pay managers fee to managing syndicate member Managing syndicate member makes full 10(spread) per bond Selling group members pay managers managers fee, pay syndicate memers additional takedown ---- receive selling concession as their compensation 6) Allocation of Orders -- Pre-Sale -- Syndicate -- Designated (order from customers stating specifically which sydicate member is supposed to be paid for those bonds) -- Member -- Member Related Acronym to remember order: Pleas Sell the Damn Munis -- no cooling off period for munis, bonds can be sold immediately after the issue is awarded 7) Confirmation: When Issued and Final Confirmation When Issued Confirmation: -- bonds are sold before they're physically available for delivery ---- Test will ask what and what isnt on When Issued statement: ------ No: settlement date accrued interest total amount due ------ Yes: trade date dated date( day interest begins to acrue on bond) price per bond Final Confirmation: -- Sent to customer on or before settlement date -- Includes all relevant details regarding the trade, including information not on the w-i confim |
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Syndicates(eastern vs western)
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Eastern Syndicate:
- AKA undivided -- if all bonds not sold, each syndicate member must take in the unsold portion based on their original percentage commitment Western Syndicate: -AKA Divided --Each syndicate member is only responsible for selling their proportionate commitment. --There is no ongoing commitment |
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The Official Statement(Muni bonds)
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Like a prospectus
Munis are exempt from SEC registration, so there is no prospectus -- MSRB requires that the issuer create a disclosure document if they want to sell the bonds to the public ---- If issuer doesnt provide statement to dealer, dealer cant sell to public so in that way they must use disclosure document to get bonds sold -- Official statement is the issuers disclosure document |
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Trading Muni Bonds
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Muni bonds trade OTC most are quoted on a yield to maturity basis
Bid Offer 6.4 5.9 The bid of 6.4 represents a lower dollar price than the offer of 5.9 --Bid is what customer receives when they sell --Offer(Ask) is what customer pays when they buy Muni bonds quoted on a dollar basis are known as dollar bonds Trading Muni Bonds is not as active or as time sensitive as trading in equities Quotes are either subject or firm -- firm is binding quote -- subject is good for info purposes only -- out firm quote, give other party time frame(15 min) to decide if thats what they want to do |
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Sources of Muni Bond Market Info
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The Daily Bond Buyer- daily publication on new issues
Munifacts- Secondary market quotes REVDEX 25- a yeild based index tracks 25 revenue bonds 40 Bond Index- a priced based index tracks 40 GO bonds The Blue List- provides a list of dealers interested in trading specific muni bonds |
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Analyzing GO Bonds
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Residents attitude towards debt and taxes
-- GO bonds backed by voter tax dollars --- more or less tax dollars means higher or lower rating Income per Capita -- more ppl with more money= more tax dollars available Industry Diversification -- town with 1 industry, negative effects could be far reaching vs well diversified town or city where negitive industry movements wouldnt be as harsh on the bond Employment -- or unemployment Debt Limits -- limit to how much GO debt muni can incur Property Value: -- prop taxes used to pay off GO bonds Assessed Value: -- prop taxes are derived from assessed values so if those go down prop tax revenue will also fall Direct Debt -- debt only muni is responsible for Overlapping debt -- debt shared with other munis -- also called coterminence debt |
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New Communication Rules
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SEC has adopted The Securities Offering Reform Rules
-- which are designed to modify and streamline the filing and communication requirements of issuers under the Securities Act of 1933 -- Communications related to registered securities offerings --Registration and other procedures in the offering and capital formation processes --Delivery of info to investors, including timeliness of that deliver -- Rules adopted have place increased importance on the value of electronic communications and filing ----have helped eliminate cumbersome and outdated filing requirements |
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What is a WKSI
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Well Known Seasoned Issuer
-- is one that within 60 days of its eligibility determination has at least 700 million worth of voting and non-voting common equity held by non affiliates -- or who has issued within the last 3 years at least 1 Billion in non convertible securities for cash(excluding common equity) --WKSI also includes a company that is a majority owned subsidiary of a WKSI |
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Free Writing Prospectus(who is allowed to do this)
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WKSI are permitted to publish written communications, before and during an offering, -----previously disallowed under Gun Jumping rules
Through a Free Writing Prospectus: --- issuer may make an offer of a security, before or after a registration statement is filed ----- A free writing prospectus must be filed with SEC A road show may be considered a free writing prospectus, depending on its delivery method |
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What is a Road Show
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is designed to provide info regarding an investment banking client and an offering of securities
Technology is now conducting many of these "road shows" electronically If electronic road show is live, it is not considered to be a free writing prospectus **However -- if the electronic roas show is recorded, it is considered to be a free writing prospectus and must be filed with the SEC |
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Prospectus Delivery
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Once the SEC has allowed an issues registration statement to become effective, sales may be completed
Investors who purchase securities in the secondary market must be given a final prospectus for: --25 days if on NYSE or NASDAQ --40 days in non listed subsequent offering --90 days if non listed IPO Mutual fund investors must receive prospectus prior to or at the time of sale |
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Exempt Issuers
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Certain securities are exempt from the registration provisions of the Securities Act of 1933 because of the issuer of the nature of the security
----No security is exempt from the anti-fraud provisions of the act Examples of exempt issuers are: -- U.S. Government -- State or Muni Governments -- Foreign National Govs -- Canadian federal and muni goverments --Insurance Companies -- Banks and Trusts --Credit Uninon and Savings and loans --Religious and charitable organizations |
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Other Offerings(smaller or specific regions)
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Rule 147:
-- pertains to offerings of securities that are limited to one state --exempt from registration with the SEC and is subject to the jurisdiction of the state securities administrator --intrastate offering, all investors have to be residents of that state, company hq in that state, 80% rev in that state, 80% assets in state, 80% raised money used in that state Regulation A offerings: --companys looking to raise up to $5,000,000 in any 12 month period -- of $5 million no more than 1.5 mill can be offered or sold by selling shareholders Regulation D offering: --Private Placement --no general solicitation --sale made to group of accredited investors where securities not offered to general public -- restricted securities |
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Purchasers Representative (private placement securities)
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Purchasers rep is an individual designated in writing by the prospective purchaser to represent them when evaluating the suitability of a private placement
Purchasers Rep may not: -- receive a blanket appointment to represent the investor for all private placements -- own more than 10% of issuers stock -- be an officer, director, employee, or affiliate of the issuer, unless they are close relative of prospective purchaser Securities received through private placements are "restricted", may not be resold by the purchaser for 6 months |
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Selling Restricted Stock
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Rule 144
-- regulates how control or restricted securities may be sold Designates: -- holding period for the security, no sales for 6 months -- amount of the security that may be sold -- filing procedures --method of sale |
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Rule 144
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In order to sell resticted securities, following must be met
Issuer must file and must be current on 10ks and 10qs with SEC Form 144 must be filed with SEC at the time any order is entered Form 144 provides a 90 day window during which the sale may be completed --- sales not exceeding 5,000 shares or $50,000 are exempt Sales under Rule 144 are limited to -- 1% of outstanding shares -- or average of the last 4 weeks trading volume, whichever is greater |
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Rule 144A
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permits the resale of restricted stock to Qualified Institutional Buyers(QIBs).
-- QIB is defined as a company that owns investments worth at least $100 million and includes ---- Corporations ---- Partnerships ---- Insurance Companies ---- Investment Companies |
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Regulation S
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Domestic issuers who make a distribution of securities to offshore investors do not have to file a registrations statement for securities under the Securities Act of 1933
-- In order to qualify for exemption offered under Regulation S -- issuer may make no offerings of the securities within the U.S. and may not announce or distribute literature relating to the securities within the U.S. |
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FINRA Rule 5130
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Broker Dealer underwriting a new issue must:
-- make a complete and bona fide offering of all securities being issued to the public -- may not withhold any of the securities for: ---- account of underwriters ---- account of another B/D ---- account of a firm employee, or the account of those who are financially dependent on the employee ---- account of employees of other FINRA members If member firm is offering its own securities for sale as part of underwriting: --member firms employees may purchase shared of the offering Member firms must identify in writing if an account is allowed to purchase securities being distributed as part of an offering |
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Telephone Solicitations Regulations
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Telephone Consumer Protection Act of 1991
-- regulates how telemarketing calls are made by businesses -- telemarketing calls designed to have consumers invest in or purchase goods, services, or property must adhere to the strict guidlines of the act -- Call only between the hours of 8am and 9pm in the potential customers time zone --Maintain a do not call list, individuals placed on list may not be contacted by anyone at the firm for 5 years -- Solicitors must give the prospect the firms name, address and phone number --Must maintain adequate policies and procedures to maintain a do not call list -- Must train representatives on calling policies and use of the do not call list |
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Insider Activities
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Insider- A company's officers, directors, large stockholder of 10% or more of the company
-- also anyone who is in possesion of non public material goods, along with immediate family members of the same Insiders must file Form 3 to notify SEC within 10 calendar days of acheiving insider status Insiders must file Form 4 to notify SEC of any changes in position within 2 business days Insiders may not earn a short swing profit or sell shares short |
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Rule 144(as pertains to insider sales)
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Control stock is stock held by control person(insiders)
Contol stockholders have no restricted periods, but are held to volume regulations Form 144 must be filed with SEC at time of order Form 144 provides 90 day window during which sale may be completed -- sales that dot exceed 5,000 shares or $50,000 are exempt Sales under Rule 144 are limited to: -- 1% of outstanding shares -- Average of the last 4 weeks trading volume whichever is greater |
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Rule 144 Volume Limits
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can sell 1% of outstanding shares or average of last 4 weeks volume whichever is bigger
Average 4 weeks volume divide by 4 |
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5% markup policy
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markups and markdowns need to be fair and reasonable
not a rule, 5% doesnt have to be charged all the time, based on a bunch of factors Price of security Value of transaction Type of Security Value of the members services Execution expenses Exemptions from rule: --issues sold by prospectus --private placements -- gov and muni securities |
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Mark-ups of Debt Instruments
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Debt securities are not as actively traded as equities
-- as a result firms must know how to calculate a reasonable mark up for a transaction in a debt instrument All markups must be fair and reasonable based on prevailing market or the dealers contemporaneous price( the price the dealer last paid) if no active market exists for the security |
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Debt Mark Up Policy(3 exempt parties)
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Transactions exempt from FINRA's mark up policy include
-- Government Securities --Munis --Transactions with qualified institutional buyers QIBs are also exempt |
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Accrued Interest
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Interest on all bonds accrues from the last interest payment date up to but not including the settlement date
-- buyer owes seller money from interest accrued from last interest payment -- use 360 days in a year, 30 days for every month(both corp and muni securities) Formula for Accrued interest= (Principal* Interest Rate) x (Number of days/360) Ex: Investor purchases 10m XYZ J&J 8% corp bond on Mon April 1 (10,000*8%) x (93/360)= 206.67 10m= 10 thousand dollar, 10 1000 par bonds January and July interest payments, and we assume payments made 1st of the month Regular Way settlement for corp bonds is T+3 Jan=30days Feb=30 days March=30days April= 3 days (buyer pays seller up to but not including settlement date) Corp and Munis the same --** Treasurys different ---- treasurys settle T+1 ----treasurys use actual days of month and 365 days a year 30 days past september, april june and november --February dont care about leap years, 28 days |
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Regualtion FD
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Requires fair disclosure of info
Regulation FD was adopted by the SEC in order to prevent the selective disclosure of nonpublic material info to securities industry professionals -- issuers in the content of a conference call with analyst and reseach professionals may not disclose non-public material info If an issuer intentionally discloses such info on a conference call, the issuer must simultaneously disclose it through a public filing or announcement if disclosure was not intentional, the info must be released to the public within 24 hours |
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Making a Tender Offer
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Tender offers may be made by a firm seeking
- to acquire a corporation - or by a corporation offering to repurchase its own shares SEC Requires: -- offers to be kept open for at least 20 business days -- if terms of the tender are changed, tender must remain open for at least 10 business days from the date of change -- The Security or a convertible security may not be purchased in the open market while the tender is open by the person who made the offer --Any company who is subject of a tender must notify and advise shareholders within 10 business days |
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What may be tendered
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An investor may only sell shares into a tender if
--long the common stock or its equivalent and have given exercise or conversion instructions for options, rights, warrants, or a convertible security ***An investor may only tender net long shares If Investor has written call options against their long stock: --amount of stock that the investor may tender is reduced by an amount equal to the number of shares covered by the short calls |
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Good Delivery
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All securities delivered by a customer or another broker/dealer must be in good condition and must:
-- be signed by all owners and all owners must be alive -- be in the correct denominations, ie: numer of shares or par value of bonds --Have all attachments (coupons) -- Be accompanied by a uniform delivery ticket (B/D to B/D form) -- must meet unit delivery rule: ---Good Delivery ---- 1 certificate for 200 shares ---- 2 certificates for 100 shares ---- 2 certificates for 60 shares and 2 certificates for 40 shares ---- 20 certificates for 10 shares --Not Good Deliver ---- 5 certificates for 40 shares ---- 1 certificate for 130 shares **Need to be makeable and breakable into 100's |
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Sarbanes Oxely Act
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Also known as Public Company Accounting Reform and Investor Protection Act of 2002
-- enacted to help restore confidence in the financial reports and accounting standards of publicly traded companies Management of publicly traded companies affirm the accuracy of the companys financial reports and accept responsibility for the content of the reports by signing all annual and quarterly reports filed under SEC act of 1934 |
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Transactions in Low Priced Stocks
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SEC Rule 15g-2 --- 15g-9
--Collectively known as "the penny stock cold call rule" --enacted in order to ensure that investorts do not purchase penny stocks without knowing the risks --Penny stock is an unlisted security that trades below $5 per share Prior to purchasing a Penny Stock: -- agent must make sure that the purchase is suitable -- customer must sign a suitability statement firm must supply a current quote Established customers are exempt from the penny stock cold call rule --an established customer is one that ----has made 3 transactions in 3 different penny stocks on 3 different days Also exempt from the rule are: --transactions executed by B/Ds whose commisions or markups from penny stock transactions do not exceed 5% of their total commissions or markups --transactions with institutional investors -- private placements --unsolicited transactions --transactions with officers, directors, or 5% stockholders |
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4 Venues for customer transactions executed
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1st
--Exchanges: auction market 2nd) --Over the counter Market: no listed securities, unlisted securities --negotiated marketplace 3rd --OTC: listed securities traded over the counter --negotiated pricing 4th --Direct Trading between Institutions |
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NASDAQ Operations
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NASDAQ quotations via level I,II,III
1) registered rep level --all info vital to making decision for customer --inside quote, best bid and best ask --bid is what customer receives when they sell, ask what they pay when they buy -- size, how many shares at those prices 2) for traders --all prices from different market makers 3)market makers -- enter their quotes into system NASDAQ Executions via "single book" aka the market center execution system Third Market executions via CQS aka NASDAQ center for listed securities NASDAQ and third market trades reported to the Trade Reporting Facility/TRF for clearing Unlisted non NASDAQ securities quoted via OTCBB and Pink sheets Unlisted securities are reported to OTC order reporting facility for clearing Fourth market consists of trades between institutions W/O broker dealers See Textbook for NASDAQ execution and reporting systems |
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Listed On NASDAQ
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Only corps who meet the listing requirement may have their securities listed and traded on NASDAQ
NASDAQ Global Market Requirements: --intitial listing requirement= $5 bid price & 3 market makers -- to continue to list: $1 bid price/ 2 market makers NASDAQ capital market listing requirements: --initial listing requirement= $4 bid price & 3 market makers --to continue to list $1 bid price & 2 market makers To list --need minimum public float and round lot shareholders Dividends or offering price are not listing requirements If de-listed, issuer must reapply to initial listing requirements |
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Becoming a Market Maker
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Market Maker
--is a firm that is required to display a two sided market and must buy or sell for their own account at prices quoted Broker Dealers who wish to register as a market must: -- apply with FINRA and demonstrate that they are in good standing with the association -- firm meets the capital requirements to become a market maker Once approved firms may register to quote securities via the NASDAQ workstation |
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How To Quote(market maker)
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Market Makers must
--display two sided quote by displaying both a bid and an ask Market Maker is quoting XYZD 29.75X29.85 9x10 if no size displayed (XYZD 29.75X29.85) market mark only needs to sell 100 shares |
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Backing Away
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Failure to honor a firm quote
--violation of NASDAQ trading practices Exceptions: Market maker is updating their quote prior to receipt of order --market maker has a "trade ahead" |
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NASDAQ Single Book
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Displays and executes order at the inside market up to 999,999 for any single order
--orders over 1,000,000 shares may be split into several smaller orders Firms may execute agency and proprietary orders Market makers may keep shares in "reserve size" additional shares not displayed |
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Bad Quotes
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If a bid is greater than the offer the market is crossed
Bid:29.70 Offer:29.20 If a bid and an offer are the same the market is locked |
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Regulation SHO
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All firms are required to make an affirmative determination for all sell orders entered on behalf of the firm or a customer
All sell orders must be designated either long or short A person is considered long the security if the investor: --has possession of the security --Has purchased the security but the trade has not settled --Has issued conversion or exercise instructions for a right, warrant, option, convertible bond, or preferred stock If investor owns rights, warrants, options, or convertible security but has not issued exercise or conversion intructions --**he is not considered long the security Broker Dealer cant sell short an equity security without: --having borrowed the security --having arranged to borrow the security --without having reasonable belief that the security can be borrowed Broker Dealer can rely on Easy to Borrow list as long as it is less than 24hours old |
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Bulletin Board
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Over the Counter Bulletin Board
(OTCBB) OTCBB provides electronic quotes for unlisted non-NASDAQ securities Issuers whose securities are quoted on the OTCBB must be SEC reporting companies Quotes are firm and the size of the quote depends on the price of the security A one sided quote may be entered such as a bid or offer only |
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Trading Pink Sheets
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--Published Every month
--Quotes are Subject to verification(not firm) --Companies are not required to report with SEC but market makers must have financial info --Broker executing an order must obtain quotes from at least 3 dealers and document on the order ticked prior to executing |
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Types of Orders
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Investors may enter different types of orders to buy or sell stock
Market order= Guarentees execution, price unkown Buy Limit= Guarentees highest price but not execution Sell Limit= gaurentees lowest price but not execution Sell Stop= used to protect a profit or limit a loss on a long stock position Buy Stop= used to protect a profit or limit a loss on a short stock position Orders placed below market are reduced for dividends Bul Limits,Sell Stops: price placed below market value -- reduce for dividends Above the Market Sell Limits&Buy Stops: above market Can all be entered as day orders or good till canceled --remain open unless executed or canceled --auto canceled april and october(about every 6 months) Orders that may be left with specialists for execution -buy limits -sell limits -buy stops -sell stops Day and GTC orders ***Market orders and not held orders may not be left with the specialist |
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Processing an Order
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Brokerage firms assign departmens to handle all of the important functions of trade execution and input
Departments Are: --Order/Wire Room: routes order to market for execution --Purchase and Sales: posts trade to customer account & sends Confirmations --Margin Department: calculates money owed or due customer --Cashiering: receives & sends checks and securities |
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Protecting Customers Limit Order
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Firm is required to protect limit orders
--if a market maker executes an order for its own account at a price that would statisfy a customer limit order, the customer must reveive an execution within 60 seconds |
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Manning Rule
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Firm cant compete with customers limit order by executing an order for its own account at a price that would satisfy the customers limit
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Stock Splits
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Customer has placed GTC order, here is what happens when stock splits
Type Old New 2:1 buy100(50) buy200(25) 2:1 sell100(100) sell200(50) 3:2 buy100(100) buy150(66.6) 3:2 sell100(60) sell 150(40) |
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Trade Confirmations
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All customers must receive a confirmation for any trade executed for the customer at or prior to the completion of the transaction
Completion of the Transaction= the settlement date, the day when the buyer becomes an owner of record --when the client pays for the trade or the firm journals the securities into or out of the clients account Have to include: --customers name & account number --Description of the Transaction --trade date & settlement date -- # of shares, bonds, units --price --CUSIP number(= ss #) --Amount due or owed --commission charged for agency transaction ---- abc's=agents and brokers charge commission ---- firm acting as broker or principal= markup/downs --Markup charged for riskless principal transactions --Markup charged for principal transactions Confirmations must disclose the name of the contra party & time of the trade |
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Net Transactions with Customers
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AKA: Riskless principal transactions
Reported to the tape as a single wholesale transaction and do not include mark ups or mark downs Customers must be informed of the firms capacity and the amount of markup or down charged B/D's who, after receiving the customers order, execute that order on a principal basis with another broker dealer and fills the order at a net price to the customer: --must first obtain the customers consent Retail customers must give prior written consent on a trade by trade basis prior to execution Institutional customers may give written oral permission prior to the trade or may be sent a negative consent letter to cover all future net trades |
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Listed Securiteis Trading OTC
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Third market transactions:
--transactions in NYSE and exchange listed securities executed over the counter Quotes from all markets are displayed in the NASDAQ center for listed securities or CQS All third market trades must be reported to the tape within 90 seconds of execution Third market volume reported to NYSE |
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Consolidated Quotes(CQS)
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Quotes displayed in the NASDAQ Market Center for listed securities(CQS)
--displayed size must be 100 share or more --Quotes entered in multiple market centers must be the same --Unexcused withdrawal= out of the box for 1 business day |
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NYSE
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Is a dual Auction market
Specialist system: -- the specialist is an exchange member appointed to maintain a fair and orderly market in the securiteis in which they specialize Issuers whose securities trade on the NYSE must meet strict listing requirements and have significant public interest |
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Leaving the NYSE
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With approval of issuers board of directors
Once board oks SEC and largest shareholders are notified Dont need apporval from SEC or shareholders just need to notify them |
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Exchange Specialists
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specialist may accept limit orders for execution that can not be imediately executed
Orders left with the specialist create the specialist "book" Specialists can accpet: --Day & GTC orders --Limit and Stop orders --NYSE Super Dot bypasses floor broker and is direct to specialist book Specialist may try to obtain a better execution for a public customer by "stopping stock" -- this means by stopping stock, specialist is guarenteeing a worst case scenario or price but will try to improve upon that price |
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Trading Along(what rule?)
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NYSE Rule 92-
--prohibits member firms from executing an order for their own account on the same side of the market, for the same listed security, at a price that would satisfy a customers order, when they have prior knowledge of the customers order Rule 92 doesnt apply to: --Institutional orders --Not held orders with time price descretion --block size orders |
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Block Trading(what rule)
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Rule 97:
--block positioners, who have purchased a block of stock with value of $500,000 or greater ----may not purchase the same stock on a plus or zero plus tick during the last 20 minutes of the normal trading day Exception to rule 97: --allow trading desk with no knowledge of the firm acquiring a block to purchase the same stock wthin 20 minutes of the close |
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Protection of Customer Assets
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Customer protection rule ensures that customer funds held by a broker dealer are maintained in safe areas of the business related to servicing its customers or are deposited in a good control location:
--banks --clearing member --depository institution --B/D's vault not good control locations: --credit unions --savings and loans |
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Segregation of Securities
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Cannot comingle customer assets with firm assets
When customer purchases on margin, Broker Dealer borrows funds from bank --Bank requires Broker Dealer to put up 140% of customers securities as collateral for the margin loan |
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Regulation U
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allows broker dealer to pledge customers securities with a value of 140% of their debt
--customers excess margin securiteis not on hold as collateral with bank cant be comingled with firms other securities |
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Special Reserve Account
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B/D's have to create special reserve bank account for the exclusive protection of their customers
Weekly calculation= (credit items-debit items)x 100%= the amount to be deposited in the special reserve account This calculation may be required at the end of each week at the close of buisness --funds must be deposited no later than one hour after opening of banking business on teh second business day after compuation date, usually tuesday Monthly Calculation= (credit items-debit items)x 105%= the amount do be deposited in the special reserve account **idea is that firm always has enough to pay back customers |
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Interpostitioning
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Placement of a third party broker dealer between the customer and the best available market is known as interpositioning
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Margin Accounts
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a margin account allows investors to purchase securities without paying for the securities in full
Investor is required to deposit a portion of the securities purchase price and may borrow the rest from broker dealer Portion of securities purchase price that investor must deposit is called "margin" --amount of required deposit or margin is controlled by the Federal Reserve Board under reulation T of SEC act of 1934 FRB determines what securities are marginable |
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Paying For a Trade
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payment date is the day when the buyer of the security has to pay for the purchase
-- Under industry rules, payment date for common or preferred stock, corporate and muni bonds is 5 business days (t+5). --Payment dates are regulated by the Federal Reserve Board under regulation T of the Securities Exchange Act of 1934 If the customer fails to pay for the purchase within 5 business days, customer is in violation of Regulation T --as a result the brokerage firm will "sell out" and freeze the customers account for 90 days A margin call for less than $1,000 may be waived by the firm All extensions must be requested before the expiration of the 5th business day(additional 5 days) |
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Margin Agreements
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When customer opens a margin account they are required to sign certain account documents:
--Credit Agreement --Hypothecation Agreement --Loan consent The credit agreement states terms and conditions under which credit will be extended to the customer --it will include info about how interest is charged as well as info about the rates that will be charged The hypothecation agreement pledges the customers securities that were purchased on margin as collateral for the loan --also allows the broekrage firm to take the same securities and re-pledge or rehypothecate them as collateral for a loan at a bank to obtain a loan for the customer The loan consent agreement allows the brokerage firm to lend out their securities to customers who wish to sell teh securities short --this is the only part of the margin agreement that the customer is not required sign |
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Account Equity & SMA
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Customer Equity= Long Market Value-debit
Long Market Value= value of shares that customer bought in margin account Debit = value of loan When customers equity increases to over 50% of the long market value, it is credited to the special memorandum account or SMA --customer SMa is like a line of credit, once SMA has been created, it will remain in place untill it is used by customer Accounts with less than 50% equity are said to be restricted --to remove restriction=cash deposit, deposit securities 2x restricted amount Minimum equity=long market value x25% Short account equity= credit balance-short market value Minimum equity=short market valuex30% |
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Who is a Day Trader/Pattern Trader
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Day trading is an investment strategy defined by the entering of round trip orders, consisting of both a buy and sell order on the same day for the same security
Pattern Trader= any account that enters 4 or more round trips in a 5 day period Minimum account equity=$25,000 No Cross liens or guarentees from other accounts |
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Direct Participation Program
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In existence for a specific lifespan, all money made flows down to shareholders
--afforded single instead of double taxation of dividends Income and Exenses flow through to investors General Partnerships and Joint Ventures Limited Partnerships and S Corporations Focuses on Limited Partnerships DPP and Corp have to have: --A profit motive --associates --Centralized Management --Freely Transferable Interest(DPP= highly illequid) --Continuity of Life(usual lifespan of 30 years then it is disolved) |
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Limited Partnerships
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General Partner= Runs business
Limited Partners= provide capital(unlimited number) --no decision making Recourse Loan= limited partners may be held liable for loan Non Recourse Loan= limited partners not responsible for loan Private Placement: General Partner must accept limited partners Limted partners sign subscription agreement Public Offering --investors receive prospectus |
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Real Estate Partnerships(5)
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Raw Land
--hope people want land for a profit, speculation on capital appreciation New Construction --money raised goes to new building --lower expenses than other REP's Historic Rehabilitation --buying historic landmark --good tax credits, tax credits come off of how much you owe IRS Existing Properties --buy appartment building etc, generates income to limited partners Low Income Housing --tax credits, section 8 etc -- able to lease and get some income, but main reason is tax credits |
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Oil and Gas Partnerships
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Income Production
--well already pumping oil --you can deplete income wells --depreciation and depletion can be taken on tax returns Step out wells Exploratory-Wild Cating --riskiest, speculate where no one has drilled before --expenses are relatively low -- nice tax benefits as well Developmental Drilling --better chances of hitting oil but less tax benefits |
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Fundamental Analysis
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examine the company's financial statements and financial ratios to ascertain the companys overall financial performance
--anayst will use the following to determine a value for the companys stock Balance Sheet= Assets& Liabilities --net worth Income Statement= Income& Expenses Financial Ratios Liquidity Ratios Valuation Ratios |
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Financial Ratios
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Earning Per Share:EPS
-- will tell the analyst how much of the companys earnings are credited to each common share --Earnings available to common/# shares outstanding Earnings Per Share Fully Diluted: --will tell analyst how much of the companys earnings are credited to each common share after all convertible securities and all rights and warrants have been exchanged for common stock Price Earnings Ratio: --will tell analyst the relationship between the earnings per share and the common stock -- market price/eps Dividend Payout Ratio: Will tell analyst how much of the earnings per share were paid out to shareholders as dividends Debt Service Ratio: --will tell analyst the ability of the company to meet ther debt service |
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Industry Fundamentals
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Growth Industries
--earnings of companies in a growth industry will grow faster than the overall growth of the economy -- growth industry wont pay great dividends but good chance for capital appreciation --Tech and Computer industries Cyclical Industries -- Earnings of a company in a cyclical industry are highly susceptible to the condition of the overall economy --cyclical industries include manufacturing, raw materials, autos Defensive Industries --stay constant through economic cycle -- earnings of a company will be least susceptible to changes in overall economy --Food, pharmaceutical industries --Things that people will buy no matter how the economy is performing --Important to note that a manufacturer of military equipment is not considered defensive industry Counter cyclical industries --go counter to normal business cycle --perform well in bad economy and poorly in good economy |
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Technical Analysis
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Tech analyst uses the patterns created by the past price performance of the stock to predict the direction of the stock price in the future
Support: is created at the point to which the stock falls and attracts buyers --new buyers that are brought into the market, because of the lower price, create demand for the stock and prevent further decline Resistance: --is created at the point to which the stock appreciates and attracts sellers --new sellers that are brought into the market, because of the higher price, create supply for the stock, preventing further appreciation Upward Trendlines: --is charachterized by a series of higher highs and higher lows -- to confirm trend and trendline should provide some support to the stock Downward Trendline: --characterized by series of lower highs and lower lows --chartist would draw line connecting series of lower highs to confirm the downward trend and trendline should provide some resistance to the stock Reversals: --indicates a significant change in the price action of the stock --bullish reversal such as an upside down head and shoulders indicates the end of a downward trend and beginning of a new upward trend --bearish reversal such as a head and shoulders indicates the end of an upward trend and the beginning of a new downward trend |
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Market Theories
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Short Interest Theory:
--when interest in selling short is high, it is a bullish indicator --ultimately when lots of shorts they have to buy out of the position creating a bullish indicator Odd Lot Trading: -- many small investors will end up buying and selling at wrong time -- high level of odd lot purchases is indicative of a market top, high level of odd lot sales is indicative of a market bottom Advance Decline Line: -- looks at breadth of market, good indicator of how healthy market is -- will tell investor how many stocks are trading higher in price and how many are lower Tech analyst will always look for volume confirmation of any trend, a trend confirmed by high levels of volume in the stock or in the market as a whole Efficient Market Theory: -- believes that all of the available info is priced into the market at any given time and it is impossible to beat the market by taking advantage of price or time inefficiencies |
