General Info Flashcards
Hedging strategies with options
Buy/go long in an OPTION with a stock position.
You’re in control, so this is protective
Can still have loss, but much more limited
Sentiment? Look at stock position
protective put
Long stock & long put
Bullish sentiment
Short stock & long call
Bearish sentiment
SIPC
vs FDIC (page 356)
Securities Investor Protection Corporation - nonprofit corporation [NOT an agency of the US government, not insurance]
In event a U.S. Broker Dealer goes bankrupt. Does NOT protect against market losses
Protects each separate customer up to $500,000 in cash and securities,
*limited to $250,000 in cash
(Does not protect non-securities such as commodities or futures)
Separate customer, even if owned or controlled by same person:
Indiv acc
Jt acc
Trust acc
IRA
Roth IRA
Minor’s acc
If coverage limit is exceeded- Customer becomes a general creditor of the broker dealer
Registration-
Customer name? Receive all
Street name? Pro-rata distribution
Discretionary trade
FINRA rule 2510 & discretionary trades
Not held order
Discretionary- when rep decides ANY of the 3 As:
-asset
-amount
-activity
Rule 2510- customers have to grant discretionary authority in writing via a POA.
*Only a DURABLE POA survives the customer being declared legally incompetent
Not held- a NON dicretionary trade (3As decided by customer, not rep) where rep is not held to a time or price
Ex: Please buy 100 shares of Apple stock when the time is right
Fee based account vs commission per transaction
Customer pays fixed fee or percentage of assets under mgt-
Best for sophisticated investors placing significant # of orders
may be referred to as “wrap account”
Customer pays commission per trade
Best for average investors, buy & hold investors
JTIC vs. JTWROS
Probate- JTIC, JTWROS, TOD
Tenants in common. Each acc holder owns a % of account assets, based on contributions.
Upon death, that person’s % of ownership gets liquidated and distributed to their beneficiary
Each owner has undivided interest in entire acc. Upon death, the person’s ownership passes to surviving acc owners
Probate applies- JTIC
Probate avoided- TOD, JTWROS
ERISA- Employee retirement income security act
For private sector workers
If qualified retirement plan (QRP), can make pre-tax contributions.
Earnings are tax deferred.
Contributions and earnings are taxed as ordinary income at withdrawal.
Allows for compounding/ faster growth. 100% of earnings can be reinvested.
Does not refer to IRAs (individual) or government worker plans
Qualified Retirement Plan/QRP
ERISA applies
Private, employer sponsored plans only
Pre tax contributions, tax deferred growth. Both wd as ordinary income.
-at least one fiduciary
-non discriminatory (all full time employees, at least 21yrs old, one year of service) (part time off at least 500hrs in past 3 yrs)
-vesting schedule (employer contributions must be fully vested after 5 years of service)
Roth 401k
Employee vs employer contributions
Employee:
Post tax contributions to Roth 401k
Tax free earnings
Distribution tax free if:
59.5 yrs old and at first Roth IRA contribution at least 5 yrs ago.
Employer match:
Goes to a traditional 401k (pretax contributions, tax deferred growth, distribution is taxed as ordinary income)
IRA- prohibited contributions
Life insurance
Antiques & collectibles
Options
Real estate (physically owned)*
REITs or MBS are ok*
Annuity payout options
Selected before annuitization. Cannot be changed.
Straight life-
Highest risk, highest payout
[Nothing to beneficiary if in annuitization period]
Life with period certain -
Beneficiary only protected during period certain
Joint with last survivor-
Smallest monthly benefit bc strongest guarantee, longest expected duration.
Pays until death of 2nd annuitant
Agent or agency basis
Broker
Matches up buyer & seller
Charges commission for completed transactions
Cannot act as both broker & dealer in the same transaction. Charging a client both fees in a single transaction is a violation.
Note:best efforts underwriting is always on agency basis.
Rev muni bonds can be best efforts depending on negotiated deal (negotiated bid u/w)
Principal
Dealer
Trades its own inventory (“position trading”)
Charges markup when selling to a client
Charges markdown when buying from a client (not commission)
Cannot act as both broker and dealer in the same transaction. Charging both fees in a single transaction is a violation.
Note: Firm underwriting is always on principal basis
Ex: GO muni bonds are always on competitive bid basis.
Competitive bid= Syndicate letter
Rev muni bonds can be on firm basis depending on negotiated deal. Typically negotiated bid u/w
Negotiated offerings- agreement among underwriters
NYSE vs Nasdaq
NYSE- auction mktplace
Human trading on floor plus electronic trading
1 human DMM (direct mkt maker) per security. Human oversight can prevent and correct unusual or abnormal trading activity
Nasdaq- negotiated mktplace
Electronic trading only.
Many market makers per security (no DMMs).
Minimum stick price, #shareholders, total assets required to be listed on either one
Nasdaq quotation requirements
Negotiated marketplace- bid & ask firm quotes in round lots (100 shares or multiples of 100)
*“Backing away” is a violation that occurs when market maker refuses to honor firm quotes (FINRA rule 5220)
Firm quote- MM required to trade at quoted price if counterparts presents an order against its quote.
*Market makers are prohibited from discussing or colluding on how to price a security. Market manipulation is a violation of ‘34 Act.
Best bid
Best offer
Inside market
Best execution*
Who is willing to pay the most to buy shares
Who is willing to sell shares at the lowest price (ask)
Two best quotes: best bid & best ask
(Smallest possible spread)
Trading at the best price available from any market maker* not fulfilling at best execution is a violation.
This requirement applies in both agent and principal roles.
OTCBB- replaced by OTCQX in 2021
OTC bulletin board- FINRA operated quotation service
Real time quotes, last sales prices, volume info
-Shares registered under ‘33
-Ongoing disclosures under ‘34 (10Ks & 10Qs) files with SEC
*not subject to listing requirements such as min stock price min # shareholders
OTCQX includes both quotes AND negotiating trades via electronic messaging capability.
Penny stocks, shell companies, and companies in bankruptcy cannot be listed here.
OTC Pink
OTC Markets
Pink Sheets
Speculative OTC market- closely held, extremely small, or thinly traded companies
Quotes on OTC Pink may be one sided (both bid & ask not required)
**Doesn’t require quoted companies to file periodic reports or audited financial statements to the SEC
Lack of regulation, potential volatility
Set clear investment guidelines
Use stop limits
Diversified portfolio
OTCQX
OTCQB
OTC Pink
OTCQX- top tier OTC equity market
Subject to SEC regulation
Governance transparency
Can’t be penny stocks
OTCQB- replaced OTCBB as main market for trading OTC- no min financial standards.
Mid-tier OTC equity market. Primarily early stage and developing companies in the US & international markets. Often includes shell companies, penny stocks, or small foreign issuers
Min reporting standards
Pass a bid test
Undergo annual verification
Pink sheets- lowest tier equity market, speculative
Primary market
Secondary market
P- issuer keeps proceeds of sale. Private placements, IPOs (public company
S- party other than the issuer keeps proceeds of sale
First mkt- listed securities on exchanges
Second mkt- UNLISTED securities sold OTC
Third mkt- listed securities sold OTC
Fourth mkt- institutions trading 24x7 via ECN (electronic communication network)
Order ticket, aka order memorandum
Customer instructions & conditions
Type of order (buy, sell, sell short(
Terms & conditions (market order, limit order, stop order)
Acc#
How order was received
Whether order was solicited, unsolicited, or placed on discretionary basis
Time order was received & entered for execution
*Market order- buy or sell immediately at whatever price is available. Priority over all other types of orders.
Tools of the Federal Reserve (monetary policy)
DORM
Discount rate- Fed to bank loans
Open market operations -
FOMC arm of Fed trades with Primary Dealers
Repurchase (buy securities back from banks, putting more $ into system for banks to make loans. Drives interest rates down)
Reverse repurchase (opposite- sell securities to banks, pulling $out of system. Tightening, rates increase)
Reserve requirements
Margin requirements
Tightening- if inflation is high. Pull $ out, rates go up for borrowers
Loosening- if possible recession. Put $ in system, drive borrowers, lower rates
Yield curve & economy
Spread- narrow v wide?
Normal = short term securities have lower yield than long term securities
When? Normal, expansion
Flat= short term & long term securities have same yield
When? Uncertainty in economy
Inverted/ descending = short term securities have HIGHER yield than long term
When? Sign of recession
Low yield =low risk. Since this is more desirable to investors, no need to offer a sweet high rate.
Desirable also means you don’t need a low market price to move it.
CY current yield= return(annual dividends)/ market price
Narrow spread- competitive. Economy is good.
Wide spread- flight to quality. Economy not good, investors want safer or higher rated securities
Fiscal vs monetary policy
Fiscal- Congress & President
Keynesian/ demand side theory = increased government spending benefits the economy
(Demand for government goods & services)
Hit the gas (recession)=
Increase government spending
Decrease taxes
Pump the brakes (inflation)=
Decrease government spending
Increase taxes
Supply side theory=
Decreased government spending benefits the economy (demand for private sector goods & services)
Hit the gas (recession)=
Decrease government spending
Decrease taxes
Classical theory- Adam Smith- leave it alone
Monetary- Federal Reserve
Tighten (inflation) v loosen (recession)
DORM
Note: taxes can be progressive (higher if more $ involved- income, estate, gift) or regressive (flat tax- sales tax, excise tax [cigarettes, gas, alcohol]
Rates & the Federal Reserve
From lowest to highest
Federal Funds rate- bank to bank loans (overnight loans to maintain capitalization)
*Most volatile interest rate on the market
Discount rate- Fed to bank rate. HIGHER than Federal Funds Rate. Go to Fed only if no bank will lend to you.
Broker loan rate- bank to broker dealer loans
AKA “Call money market rate”
Prime rate-
Large bank customer loans
Typically only available to institutions
GDP/GNP- elasticity
CPI
Yield curves
GDP- how’s your stuff selling?
Elastic goods & svcs “we can wait”- house, car, fridge
Inelastic “we need it”
Medical supplies, concert tix
CPI- how expensive is your stuff?
Sign of inflation
Yield curve-
normal= growth (short term =low yield, long term =high yield)
Flat= uncertainty
Inverted/ descending = recession = short term higher yield (high yield =high risk)
Business cycle
Stagflation
Recession v depression
Expansion:
Decreased unemployment
Increased GDP
-inflation risk if growing too quickly (higher prices & COL)
Peak:
Beginning of downturn
Contraction:
Increased unemployment
Decreased GDP, manufacturing output, hold income, bz profits, investment spending
Trough:
Lowest point. Contraction turns to expansion here.
Stagflation- slow economic growth plus rising prices, inflation, & relatively high unemployment
Recession =GDP decline 2 consecutive quarters (6mo)
Depression = GDP decline 6 consecutive quarters (1.5yrs)
Leading indicators
-bond yields (yield curve)
-S& P 500
-INITIAL claims for unemployment (weekly)/layoff rates
-Index of NEW manufacturing orders
-# of NEW building permits
-Consumer confidence index
-Spread between 10 yr Tnote & Fed Funds Rate
Recession indicator= Fed Funds Rate HIGHER than 10 year T note
Coincident indicators
-#employees on non farm payrolls
-avg hours worked
-personal income levels
-industrial production levels
-manufacturing sales
-unemployment rate
Lagging indicators
-changes in CPI levels
-corporate profits
-CHANGE in labor cost per unit of output
-avg DURATION of unemployment
-Prime Rate & other interest rates
-commercial & industrial loans outstanding
-inventory/sales ratio
Yield spreads
Comparing yield of low risk T bonds to comparable non- Treasury bonds
Remember:
High yield = high risk
Spread widens- market forecasting more risk of default on lower grade bonds
*Flight to quality- could drive up price of Treasuries, decreasing yield (annual dividends/market price)
Spread narrows- market forecasting less risk, possibly due to growing economy
Inflation and bond prices
Increased inflation (higher interest rates) leads to decreased bond prices
Interest rates & bond prices have inverse relationship
Inflation and…
Cash
Bonds
Stocks
Real estate
Cash- higher savings rates but lower purchasing power (inflationary risk)
Bonds- prices drop when interest rates rise. Lower market value
Stocks- moderate inflation can increase values. High or unpredictable levels can hurt corporate profits
Real estate- positive relationship between R/E and inflation due to higher cash flows and asset values
Cyclical stocks
Defensive stocks
Cyclical- mirror the economy
Elastic goods & services= cars, large appliances
Defensive- resistant to downturns- supply basic needs
Inelastic goods & svcs- utility stocks, medical supply stocks, stocks of staple consumer items, stocks of discount retailers
*Note that concert tix are considered inelastic, as well as alcohol & tobacco
Shareholder equity (on balance sheet)
Vs working capital
Capital structure/ capitalization
AKA net worth
SE= Total assets- total liabilities
WC= current assets- current liabilities
Measure of firm’s liquidity
Current Asset-expected to be converted to cash within the next 12 mo
Current Liability-due for pmt within the next 12 mo
shareholder equity- 3 types
-capital stock at par
-capital stock above par- most stocks are sold above par when initially issued
-retained earnings
Capitalization = long term debt + equity securities
Capital structure: relative amounts of debt vs equity composing a company’s capitalization
US interest rates and impact on foreign trade
Interest rates: up
Dollar value: up
Exports: down (costs more for others to buy from us)
Imports: up (cheaper for us to buy from others)
Note: our $ leaving is a debit, pushing towards a deficit
Interest rates: down
Dollar value: down
Exports: up (our stuff is cheap when Dollar is weak)
Imports: down (our money doesn’t have much purchasing power)
Note: exporting our stuff & bringing currency into the country is a credit
Balance of trade= difference between a country’s exports and imports
Overall trade deficit
Because we import more than we export (oil, cheap consumer goods)
Income strategies with options
Sell/go short in an OPTION with a stock position. Can get income in flat market, but quite risky in volatile market
Market sentiment- neutral
Major opportunities for losses!!
covered call
long shares and short call
Gain the premium. Make a little if market goes up- plus the premium.
If market goes down & contract expires, still major loss (but you got your premium)
covered put
short shares and short put
Gain on the premium. If market drops, have to buy stock back & make a little money (plus premium).
If market rises, contract expires. Eventually have to buy back at higher price & take an almost unlimited loss- partially offset by the premium
Record retention
3 years
Employee records (U4,U5,fingerprnts)
4 years
Customer complaints (FINRA)
5 years
CIP info (Cust ID program)
CTRs (file within 15 days)
SARs (file within 30 days)
6 years
Cust acc records (agreements, new acc forms)
Blotters
Customer complaints (MSRB)
lifetime
Stock certificates
Partnership agreements
Articles of incorporation
Meeting minutes
Settlement timing:
stocks, muni, & Corp
US government, options trades
Options- exercise
“Regular way” T+2
Clearinghouses, ex: DTCC
US government & options trades T+1
Government- federal funds system (trade OTC only)
Options- OCC (trade on CBOE, NYSE, Nasdaq, PHLX)
OCC does not set the premium
Exercise of equity options contract:
Most- American- exercise at any time- T+2 with delivery of cash vs securities
Index options- European- exercise at expiration only- T+1 for cash equivalent of the value of the stocks in the index (VIX index is Inverted to market)
OEX index is the only American style index option
Muni bond underwriting-
Order priority for new issue muni
Pretty good Dino movie
Pre-sale
Group (net)
Designated
Member
Municipal bonds- choosing cheapest underwriter
Factor in time value
TIC
True interest cost
Considers time value of money. Weights early interest costs more heavily
NIC
Net interest cost
Does not factor in time value
Variable life insurance - numbers to remember & unique fees
Max sales charge?
Policy loans- possible when & for how much?
Mortality risk fee covers risk that insured lives longer or shorter than actuarial est.
Investment mgt fee- manage separate acc
Right to exchange for a normal life insurance policy- at least 2 years
No medical underwriting/ evidence of insurability.
New policy issued as ID retroactive (p.242)
Sales charges- max 9% up to 20 yrs
(Renewal commissions pd up to 20 yrs)
Free look period- 45 days from application or 10 days from receiving the policy (whichever is longer). Receive back all pmts made.
Refund provision- within 2 yrs, early termination = return of cash value plus % of sales charge.
After 2 years, only return cash value.
Insurer keeps sales charges.
If separate account outperforms AIR target, death benefit & cash value increase (& vice versa- but death benefit never below guaranteed minimum)
Policy loans- after policy in place 3 years and at least 75% of “cash value” must be made available
Variable annuities
Accumulation
Annuitization
Max sales charge?
Taxation
Death benefit fee (rider)
Beneficiary’s basis?
Most are “non-qualified”: after tax contributions, tax deferred growth, growth & earnings taxed as ordinary income
No max sales charge
Separate account acts as a UIT/ security- prospectus must be delivered
Initial payment determined by insurance Co actuaries.
If separate acc outperforms AIR (target), the next month’s payment to annuitant increases.
At AIR? Stays same.
Below AIR? Payment drops
Annuitization:
-Fixed # annuity units
-Fixed # units liquidated per month
-Variable payment based on unit’s value
Withdrawals: 3 kinds, pre- annuitization is typically LIFO-
Last in (earnings) first out
random LIFO
lump sum LIFO
annuitization monthly combo of (after tax) principal & (taxable) growth
exclusion ratio taxable percent of monthly payments
Death benefit fee- if annuitant dies during Accumulation period, beneficiary gets the greater of: MV or amount invested
Beneficiary of annuity? Carryover basis (same basis as the annuitant paid originally)
Stepped up basis only applies to Inverted stocks/bonds etc.
Valuation adjustment timing with Variable Life Insurance-
Separate account
Cash value
Death benefit
Life:
Separate- daily
Cash value- monthly
Death benefit- yearly (never below guaranteed minimum)
Partnership/ DPP- how issued? Docs?
Recouse loan
Non-recourse loan
Key features
syndicator oversees selling and promo of DPP. Max fees 10% of gross dollars of securities sold.*
Max 10% comp includes any amounts paid to wholesalers p. 313& 328
Total max: 15%
Additional 5% for administrative, organization, & offering expenses
Private placement (Accredited investors) w/ Private placement memo
Or
public offering with prospectus
3 additional docs:
cert of limited partnership file in partnerships home state. For legal recognition. Includes dissolution details.
partnership agreement given to each partner. Lists rights/responsibilities of GP & LP, dissolution details
subscription agreement Each interested investor fills out. GP is given POA over partnership. GP must sign to approve.
Recourse loan- all partners proportionately liable
Non-recourse loan- only GP liable
Non-recourse loan (GP) and real estate DPPs- add to investor’s basis
Key features-
GP has unlimited liability & does the management- has at least 1% financial interest
LP have limited liability
Pass through of income, gains, losses, and tax benefits (depreciation, depletion, tax credits)
DPP- roll up
Compensation & solicitation of roll up
Combo/reorg of limited partnership(s) into securities of a successor corporation
Disclosure docs needed. If fail to disclose negative opinion re: fairness, this is fraud
IF partner’s comp is:
-unrelated to vote
-no more than 2% of value of securities to be received
THEN solicitation of votes on roll up is not prohibited
REITs
Negative correlation to stock market
Publicly traded= liquidity
Pass through gains if 90% NII distributed & 75% income from RE
Taxation:
Dividend = ordinary income
Cap gains = long term
Trusts!,
Hedge funds
Fund of Hedge funds
Hedge fund:
Unregulated, usually org. as limited partnership with Private placement memo, <100 Accredited investors
-lack of transparency
-aggressive, speculative
-lock up periods
- high management fees (2&20)
May target:
Blank check company (SPAC/ special purpose acquisition co) with no business operations & focus of mergers & acquisitions.
No proposed investment intent disclosed
Blind pool some indication of industry or sector, but no disclosure of specific use of proceeds
Fund of hedge funds- registered mutual fund.
Lower entry cost & accessible to regular investors.
Still: high risk, high management fees, low liquidity
Asset backed securities ABS
Amortizing CDO
Nonamortizing CDO
Securitization of underlying assets such as mortgage, auto loan, CCs, leases, royalties etc
Title to assets is transferred to an SPE/ special purpose entity.
SPE then issues the ABS.
CMO- asset is residential mortgage, often backed by federal agencies so usually highly rated
suitability form required from client
Principal is repaid to one tranche at a time. p.336
CDO-not backed by a specific kind of debt, but usually non-mortgage
Amortizing- ex: auto loan CDO
Investor’s return includes both principal & interest
Nonamortizing- ex: credit card CDO. Debt has no fixed ending date
CMOs-
as industry standard- cannot be compared to other investment products
Classes of CMOs
Pools of mortgages on residential properties. Repaid in tranches.
Interest is applied across all tranches, but principal only paid towards ONE until it is PIF. Then principal is all paid towards the next tranche.
Min investment $1000
Interest portion of payment is taxable as ordinary income.
(Principal portion only taxed if sold at a discount.)
Not suitable for small or unsophisticated investors due to complexity.
Investors must sign suitability statement
Standard CMO P&I pmts- see above
PO- principal payments only
sold at deep discount- volatile
More valuable when rates fall & more of pmts go to principal
IO- interest only
sold at discount
More valuable when rates rise & more of pmts go to interest.
Note- never know how long income stream will last
PAC- planned amortization class
Paid off first
Protection from prepayment risk & extension risk
TAC- targeted amortization class
Protection from prepayment risk only
Strategies with potential for unlimited loss
Short stock
Short call (naked)
Always cover your shorts!
Income strategies with options
Very risky
Use to generate income in a flat mkt
Stock position with a short/sold option
Sentiment? Look at the stock position
covered call
Long stock with short call
Bullish/ neutral
covered put
Short stock with short put
Bearish/ neutral
Naming the spread-
What is position, sentiment, & debit v credit re: Premium (buyer v seller role?)
Which is dominant leg?
Where did the investor put their money? Which one would make the most money for the investor?
Premium
Leg with higher Premium is dominant . Investor put the most money/ emphasis here.
Strike price/ price-[VP, vertical]
Which can make the most $$?
call spread
Lowest strike price is dominant - “Call up” the furthest
put spread
Highest strike price is dominant - “Put down” the furthest
Expiration/ time [HT horizontal]
More time for market to move =more value for investor
Later expiration is dominant
4 step options spread system
Identify dominant leg & strategy first
Buyers lose, sellers gain!
What do they lose or gain?
The premium!!
-Who are you?
-Are you 5 letters (buyer, debit, widen, user, owner) or 6 letters (seller, credit, narrow, expire, writer)?
-Bullish or Bearish based on dominant leg?
1- net the premiums (NP)
This is either max loss or max gain, depending who you are.
If you’re the buyer, buyers lose= ML
If you’re the seller, sellers gain=MG
2- Net strike prices (NSP)
3- NSP- NP
This is your “other side” of max gain or max loss
4- SP +/- NP
Strike price +(call up) or - (put down) Net premium
This is your breakeven
Dominant leg strike price linked to Net premium of the two contracts
Elements of a collar
AKA hedge wrapper
Protective of the stock position
Stock can’t move too far, like dog with collar & leash
-Short call- OTM
-Long stock
-Long put- OTM
Elements of a spread
-Buy & Sell
-Same underlying security
-Same class (ex ABC call & ABC call)
-Time (expiration) and / or -price (strike price) are different
VP= vertical spread- price is different
vice president
HT=horizontal spread- time is different
Harry Truman
DTP- diagonal spread- time & price are different
Drink the prosecco
Elements of a straddle
Long straddle vs.
Short straddle
-Call & put
-all other elements identical, including time & price (expiration, strike price)
Long straddle= buy
(Long/buy/own)
Buy…….call
Buy…….put
Only appropriate for:
-Sophisticated investor
-Volatile markets
Or
Short straddle= sell
(Short, Sell, owe)
Sell……call
Sell……put
Only appropriate if:
-Aggressive options trader w high net worth
-Flat market expected
Short straddle
Remember BLSG
What do they lose or win? The premium!!
Contract quote is identical except it’s a call and a put
Only suitable for:
-Flat market
-Aggressive trader w wealth
(Think- ride out flat/neutral mkt)
Short straddle is seller-
Sellers gain…the premium
Max gain= combined premiums
Max loss= unlimited
2 breakevens=
Strike + combined premiums
Strike - combined premiums
Profit where?
Seller/narrow
Profit between the breakevens
Long straddle
Remember BLSG
Where do you profit?
Matching quotes except it’s a call & a put
Suitable for:
-aggressive options traders
-volatilty expected
(Think- take control in volatile mkt)
Long=Own= buyers lose. Lose what? The premium
Max loss= combined premiums
Max gain= unlimited
2 breakevens=
Strike + combined premiums
Strike- combined premiums
Profit where?:
outside of breakevens (above or below)
Remember- 5 or 6 letters-
Buyer, widen
Elements of a combination
Looks like a straddle (call & put)
But Time &/or price are different
Long combo= call & put are both BUY
Sentiment= volatility
MG=(buyers lose)= combined premium
ML= unlimited
B/E (2)=
Strike (put) - combined premiums
Strike (call) + combined premiums
Short combo= call & put are both SELL
Sentiment = flat
MG(seller)= combined premiums
ML= unlimited
B/E (2)=
Strike (put) - combined premiums
Strike (call) + combined premiums
Elements of a strangle
Long or short combination where both legs are “out of money”
Recall: combo is a straddle where T +/- P are different
Index options
Why use?
American vs European
Trade vs exercise settlement
Options with indices as underlying asset can be used to hedge against market risk
Indices- most are European
Exercise at close
-SPX
-DJX
-RUT
-VIX (inverse to market)
-OEX- American style
Exercise anytime
Trade the contract T+1
Exercise the contract T+1 for cash equivalent of the underlying index
Beta
Measure of portfolio volatility vs. Market
Higher beta? Need more protection (more volatile than mkt)
9.6.2 achievable
“Market risk is measured by a security’s beta”
P.376
High beta- tech, autos
Low beta- utilities, consumer Basic staples
VIX options
Index option, so European exercise &
T+1 for both “the deal” and “the underlying asset”
Sentiment questions- VIX moves inverse to market
Expiration:
The Wednesday 30 days before the 3rd Friday of the following calendar month
Options contract size & key points
-Standard options
-Mini- options
-Foreign currency options
-Yield based options aka interest rate options
Normal 1=100
Mini options 1=10
Foreign currency 1=10,000 (1K)
Yen 1= 1,000,000 (1MM)
Foreign currency- premium is in cents, not dollars
NOTE: USD options do not exist
If this is offered as an answer, it’s wrong
yield options (interest rate options)
After your T chart is done, adjust by moving decimal one place to left
Strike= 10 x YTM
Yield based TYX index is based on the most recently auctioned Treasuries, so interest rates and yields move together
Synthetic long stock
Long call & short put (matching)
Behaves as if you owned the stock
Position limits on options contracts for a particular security
Exercise limits on options contracts on a particular security
Who sets
How much
Positions:Bullish vs bearish
Set by OCC
Position & exercise- Usually 250,000 on each side (bull v bear)
Exercise limits- max # contracts exercised on either side of market within 5 consecutive bz days
🐄 Bullish: Long call, short put
🐻 Bearish: Long put, short call
Long stock- then buy a put as a hedge
Tax implications-
Stock is LT before purchasing put
Stock is ST before purchasing put
Stock & put purchased SAME DAY
If stock was already held OVER a year (long term), then proceeds at sale are still long term capital gain/loss
If stock was short term (one year or less), then holding period resets to zero when you buy the put. Doesn’t begin aging again until put expires
married put basis of Stock is the net cost of both.
Holding period is unaffected by put- starts on settlement date
MPT modern portfolio theory
Securities in portfolio should have a negative correlation
Diversify out of (non-market) risk by:
-Combining volatile & price stable securities
-Including assets whose prices move inversely or at different times
Note: MPT & CAPM assume no nonsystematic risk- only market risks
MPT- modern portfolio theory- diversify to reduce volatility
(Assumes NO specific/bz related risks)
CAPM capital asset pricing model
(Cap-m)
Beta
Alpha
CAPM- Theoretically appropriate required rate of return based on level of risk in an investment.
Calculates a required rate of return based on the beta
Beta- level of volatility vs. market; a risk multiplier.
Analyst calculates expected return based on beta
Alpha- ACTUAL return vs expected return.
Negative Alpha- investor’s return was too low for the risk taken
Positive alpha- investor’s return was better than expected in comparison to level of risk they took on.
indicates a ‘buy’ recommendation
CAPM and Alpha alpha= portfolio outperforms CAPM required return (based on beta).
Positive alpha is desired, points to skill of portfolio manager
was the fund manager’s performance sufficient to justify the risks taken to get the return?
Financial statements-
Balance sheet
Income statement- 3 elements
Balance sheet- snapshot of financial position at a specific point in time.
total assets- total liabilities =owners’ equity
Balance sheet does not indicate whether bz is improving or deteriorating
Income statement aka P&L statement
Summarizes revenues and expenses for a fiscal period.
used to judge efficiency & profitability of a company’s operation
Revenues- gross sales, money in
COGS cost of goods sold, money out
Pretax Income what’s left
Pretax Income = operating income - interest pmt expenses (corporate debt)
Revenue - COGS= gross operating profit
Soft dollars and safe harbor
Commission pmts to brokerage firm that are used, in part, to pay for other services such as research.
Criticized for lacking transparency & hiding abuses.
P.386
Advisors must disclose soft dollar arrangements to clients (per SEC)
What falls under sec 28(e) of ‘34 “safe harbor”?
-Research reports
-Financial newsletters & trade journals
-Analytical software
-Seminars or conferences
-Effecting & clearing trades
safe harbor for expenses paid with soft dollars that offer a direct research benefit
Technical analysis- theories
Odd lot theory- less experienced investors can’t afford round lots (sets of 100 shares). Less experienced investors often guess wrong about the market.
If analyst sees odd lots doing an activity (ex. buying a security), they’ll do the opposite.
Short interest theory-
Short interest measures % stock sold short. Remember, these investors MUST buy back the security to return it.
High short interest is actually a 🐄 Bullish indicator bc closing purchases will have to start soon.
Low short interest means normal sales. Nobody is obligated to buy, so this is 🐻 Bearish indicator.
efficient markets theory
works within the Dow theory
Market prices instantly reflect new public info
Dow theory
If all of the Dow averages move in the same direction, new trend.
If the 3 Dow averages move in different directions, there’s uncertainty.
3 indices-
DJIA -industrial
DJTA -transportation
DJUA -utilities
3 types of mkt trends:
within Dow theory
Main/ primary- 1yr+
Medium/secondary- 3-12 weeks
Short/ST fluctuations- hours or days
Wash sale
Do not confuse with tax swap of a bond.
Only a wash sale if issuer, coupon, & maturity all match.
If investor has net capital losses, up to $3000 can be used as deduction against ordinary income
Selling security at a loss and purchasing substantially identical security within 30 days before or after the trade date
If you do a wash sale, you lose tax benefits of the CL. Old basis & proceeds are factored into new basis.
P.370
Substantially identical examples:
-Securities convertible into one sold
-Warrants to purchase the one sold
-Rights to purchase the sold security
-Call options to purchase the one sold
note- options of different series are not considered substantially identical
(Ex different expiration months)
Selling shares & taxation
IRS default- FIFO- may produce higher taxable CG in rising mkt
Stocks- SH may elect share identification. SH tracks cost of each share purchased & liquidates shares that provide the lowest CG
Mutual funds- SH may elect
not used for stock
average cost basis. Total cost divided by total shares.
Can’t use on stock
SH can’t change decision to use this method without IRS permission
Cost basis & taxes
Inherited securities
unlimited marital deduction
estate taxes due 9 months after death
Gifted securities
gift taxes due tax filing day (April 15)
Note: Inherited annuity (beneficiary) basis?
Inheritance-
Basis is FMV as of date of death (NAV, if open end investment co). This is known as stepped up cost basis.
-estate tax pd by estate
No estate or gift tax between spouses. Estate taxes are due at death of the survivor
Gift- recipient’s basis & holding period is the same as the donor’s (received securities plus tax implications of CG)
carryover basis
-gift tax pd by donor.
Amount of gift is the FMV as of date of the gift.
Note: can donate up to $17,000 per year to any number of individuals without incurring gift tax
unified credit
Taxation of estate & gifts are unified.
Whatever is used of lifetime gift exclusion before death reduces the estate tax exclusion
Inherited annuity basis?
Carryover basis
C corporation-
Corporate dividend exclusion
When corporation owns stock in another corporation & receives dividends from the investment,
50% of the dividends received are excluded from the owner corporation’s income
Diversification vs asset allocation
Asset allocation- how is the pie divided?
Mix of Asset classes (stocks, bonds, cash)
Diversification- what’s within that piece of the pie (asset class- ex lots of types of bonds)?
Investing among different types of securities, markets, & industries
Bond buyer
40 bond index
20 bond index
11 bond index
Revdex 25
Published each bz day
Rising index= bond prices are rising (yields are dropping)
40- GO & Revenue- daily
20- GO- mid rated & up- weekly
11- subset of the 20 GO- higher rated- weekly
Revdex- Revenue- midrated- weekly
Types of margin accounts
Long margin- borrow $$ to buy/ go long the securities.
Must return $$ (+interest)
Maintenance requirement= 25% equity
Short margin- borrow securities (to sell for cash/ go short).
Must return securities.
Maintenance requirement= 30% equity
Margin accounts and commingling
Margin securities may be commingled w securities owned by other customers (but not BD).
Fully paid securities must be segregated.
Margin accounts
FRB vs FINRA requirements
FINRA-
$2000 rule
Maintenance of 25% (long)
Maintenance of 50% (short)
FRB-
Reg T
50% initial funding
NYSE DMM trade fulfillment- order
3 Ps
1 Priority- first in
2 Precedence- largest of those submitted
3 Parity (random)
State registration vs notice filing
Qualification- register with state only
Coordination- register with state & SEC
Notice filing- no registration w state
Just file a notice stating:
Going to offer in- state
State can assess a fee
